The US Federal Reserve (Fed) raised interest rates by 25 basis points yesterday evening, lifting its federal funds target range to 5.00% to 5.25%. This marked the third straight quarter-point hike by the Fed, bringing the federal funds rate to its highest level since 2007, when it also stood at 5.25%. Rates were last higher in 2001. Forward guidance about the future in the statement released alongside the announcement said that “in determining the extent to which additional policy firming may be appropriate” it will consider its previous monetary policy decisions which may have lagged effects “and economic and financial developments”. This marked a relaxation from the Fed’s previous statement in March, which stated that some additional policy firming may be appropriate.

Annual inflation – as measured by the Consumer Price Index for All Urban Consumers (CPI-U) – eased for a ninth consecutive month in March, reaching 5.0%. Nevertheless, core inflation remains stubbornly high, amounting to 5.6% and exceeding the headline rate for the first time since December 2021. The persistently high rate of core inflation will have added to the reasoning for this latest rate rise. Yet the slowdown in the headline rate has been driven by falling prices in wholesale energy markets, with energy’s contribution to price growth now negative. This trend is expected to continue over the coming months, which will put further downward pressure on inflation, all else equal.

Monetary policymakers have been closely analysing the wave of bank collapses in the United States, most recently First Republic, and the takeover of Credit Suisse in Switzerland. These events have raised concerns about banking sector stability and caused a decline in regional banking shares in the US. While the Fed has a clear mandate to bring down the rate of inflation to 2.0%, it is also concerned with maintaining financial stability, and further interest rate rises risk placing pressure on a fragile system. Therefore, this concern about banking sector turmoil in addition to expectations that inflation will continue to fall, suggests that yesterday’s latest rate rise may be the final one as part of the Fed’s monetary tightening campaign, a view that is shared by markets which currently price in three rate cuts by the end of 2023.

Rate setters will be monitoring developments in the inflation data and banking sector closely. Higher interest rates, combined with tougher access to credit due to the banking sector turmoil and disappointing Q1 GDP data, paint a difficult picture for business activity in 2023. Indeed, Fed chair Jerome Powell acknowledged yesterday that the banking crisis was “resulting in even tighter credit conditions for households and businesses” which will weigh on economic activity as well as inflation. Overall, Cebr’s latest forecasts expect annual GDP growth of 0.8% for the US in 2023, which would mark a significant slowdown from 2.1%, seen in 2022.

Josie Anderson is Managing Economist at the CEBR.

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