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US Fed is considering more rate hikes after banking turmoil


US banks will be paying particular attention to the Federal Reserve’s interest rate decision on Wednesday after two weeks of market turmoil over the collapse of three regional lenders.

The US central bank is balancing between continuing to raise interest rates to combat high inflation and applying the brakes to prevent further unrest in the commercial banking sector.

A stock market rally earlier this week reinforced calls from most analysts that the Fed will hike rates again, despite broader concerns about the financial sector.

The majority of futures traders are predicting that the Fed will raise its benchmark lending rate by 25 basis points to a range of 4.75-5.00 percent, according to CME Group.

That would be in line with the size of the central bank’s previous rate hike in February, and would be the ninth hike since the tightening of monetary conditions began last year.

Despite these efforts, price increases remained well above the Fed’s long-term inflation target of 2 percent.

Hot data and banking uncertainty

The implosions of Silicon Valley Bank (SVB) and two other regional lenders ravaged banking stocks around the world last week, with Credit Suisse swallowed by Swiss rival UBS after its shares plunged to record lows.

Asian equity markets and most European indices rose ahead of the Fed’s decision on Wednesday. But UK inflation rose unexpectedly last month, despite a concerted effort by the Bank of England to deal with rising prices.

Wall Street stocks opened nearly flat on Wednesday as investors await the Fed’s decision.

Regional banks in the US opened lower before recovering some losses. Beleaguered First Republic Bank fell about 2 percent in 30 minutes after trading began, while PacWest Bancorp lost nearly 4 percent.

The combination of hot US economic data at the start of the year and uncertainty in the banking sector has led most analysts to predict that the Fed will continue with a more modest interest rate cycle than previously predicted.

“After the recent news, the recent developments in the financial markets, we now see some kind of risk for both parties,” Stephen Juneau, senior US economist at Bank of America Global Research, told AFP.

“We are still looking for a 25 basis point increase in March, May and June,” he said.

– More ‘Davian’ language use –

Treasury Secretary Janet Yellen said on Tuesday that the US banking sector “stabilized” after authorities intervened to protect deposits following the bankruptcy of SVB and Signature Bank.

But she admitted that “similar actions may be warranted if smaller institutions face deposits that carry the risk of contagion.”

Yellen’s comments contributed to this week’s relief rally in stock markets, along with moves by the Fed and other major central banks to improve lenders’ access to liquidity.

The challenge for Fed Chairman Jerome Powell on Wednesday will be to get the message across that the banking system has turned a corner as it continues to fight inflation.

“The Fed will have to emphasize that it has a dual mandate of full employment and stable prices, the latter still far from being fulfilled,” Oxford Economics chief economist Ryan Sweet wrote in a note to clients.

It’s likely “slightly softened” in the language accompanying the decision, Bank of America’s Juneau said, adding that he expects the U.S. central bank to bolster its confidence in the banking system in the statement.

The Fed will also update its GDP growth and interest rate forecasts on Wednesday.

The announcement follows the European Central Bank’s decision last week to raise interest rates by 0.5 percentage point.

ECB chief Christine Lagarde warned on Wednesday that euro zone monetary policymakers “will still have ground to ensure that inflationary pressures are quelled”.

She said the recent banking turmoil could add to “downside risks” in the single currency area.

Joanna Swanson

Joanna Swanson is Europe correspondent at the Thomson Reuters Foundation based in Brussels covering politics, culture, business, climate change, society, economies and inclusive tech. With specific focus in breaking news, she has covered some of the world's most significant stories.