Despite Bank Collapse – Highest Level Since 2007: Fed Continues to Raise Interest Rates

The most recent bank collapse in the US – the collapse of the First Republic Bank – has not stopped the Fed from slightly raising interest rates. Now, however, an interest rate break could follow.

Interest rate turnaround announced a year ago
In making its decision, the Fed had to make a trade-off between alleviating concerns in the banking sector and combating high consumer prices. In the past year, the Fed had raised interest rates by as much as 0.75 percentage point several times. The central bank had thus set a pace it had not seen in decades. She initiated this interest rate turnaround more than a year ago – when the policy rate was close to zero. Recently, however, the Fed has opted for smaller rate hikes. According to the forecast released in March, decision-makers at the Fed expect the key interest rate to average 5.1 percent by the end of the year. This value has been reached with the current increment.

turbulence in the banking sector
The Fed’s aggressive rate hikes have also caused some of the turmoil in the banking sector. The collapsed banks were insufficiently protected against rising interest rates. For example, these have lowered the market value of their securities holdings. With the First Republic Bank, another struggling US money house has just collapsed. It was announced a few days ago that the industry leader JP Morgan Chase was buying the troubled bank in a state-coordinated bailout. After the collapse of Silicon Valley Bank and Signature Bank in March, it initially seemed as if the turbulence was over.

Further increases could unsettle the market
The Fed must now provide a balancing act in its monetary policy – as further significant rate hikes could upset the market. At the same time, consumer prices in the US are still too high. Controlling inflation is the traditional task of central banks. If interest rates rise, individuals and the economy have to spend more money on loans – or borrow less money. Growth is slowing, companies can’t just pass on higher prices – and ideally inflation is falling. At the same time, there is a risk that the economy will come to a standstill.

US labor market robust, but consumer prices high
High inflation in the US has recently moderated more than expected. In March consumer prices rose by 5.0 percent compared to the same month last year. It was the lowest increase since May 2021. But that figure is still far from the Fed’s target inflation rate of 2 percent on average. At the same time, the labor market remains robust. However, what actually sounds good could drive up consumer prices even further. Because a strong labor market is generally seen as a driver of wages and therefore of inflation.

Debt ceiling controversy
The recent turmoil in the banking sector could have a similar effect to interest rate hikes and weakening demand due to more cautious lending. Fed Chairman Jerome Powell recently relied on that as well. There is currently turmoil in the markets, but also because of the dispute over the debt ceiling. US Treasury Secretary Janet Yellen warned that the world’s largest economy could go bankrupt as early as June 1 if the debt ceiling is not raised. This also weighs on the US economy and could weigh on growth.