Federal Reserve

The U.S. Federal Reserve continued its inflation fighting ways on May 3 after it lifted its key lending rate by 25 basis points from a target range of 5.00% to 5.25%. This represents the 10th straight interest rate hike and the highest level since the autumn of 2007. Since it started raising interest rates in early 2022, the Federal Reserve has increased its overnight lending rate by a cumulative 4.75%.

Why Did the Federal Reserve Raise Interest Rates?

In a statement, the Federal Reserve removed a sentence that had been in its March statement, that said “some additional policy firming may be appropriate” to get the annual inflation rate down to the central bank’s two percent target. This meant more interest rate hikes. And it was true to its word. But the April increase was unanimously expected by Wall Street and Bay Street analysts.

The Federal Reserve replaced its previous statement with one that suggests it will need to look at a range of factors in “determining the extent” to which possible future rate hikes may be needed. And judging by the strong economic data coming out of the U.S., there is every reason to believe that just because the Fed has hinted it will pause future interest rate hikes, it could leave the door open to another rate hike at its next policy meeting in June.

How Is the U.S. Economy Doing?

In the U.S., the consumer price index (which tracks inflation) was up five percent for the 12-months ended March 31. The core index, which includes everything except food and energy, was up 5.6%.

U.S. job openings pulled back for a third consecutive month in March with the number of layoffs hitting a near two-year low. The number of job openings totaled 9.59 million in March, down from 9.97 million in February. This suggests there is some softening in the labour market, which could help the Federal Reserve in its fight against inflation.

That said, the U.S. labour market still remains tight. March job openings, or the number of unfilled positions per unemployed worker, showed 1.6 vacancies for every unemployed person in March. This is the lowest level since late 2021 and 1.7 in February.

With U.S. inflation running at 4.98%, “inflation pressures continue to run high, and the process of getting inflation back down to two percent has a long way to go,” Chair Jerome Powell said.

Still, there’s more to consider than just the job market and inflation when it comes to interest rate hikes. A string of successive rate hikes has made it more difficult for many banks, including banks like Silicon Valley Bank and First Republic, to match the higher rates on the loans. The two banks failed after depositors withdrew their holdings to higher-yielding investments.

Volatility in the banking industry forces the Federal Reserve to weigh the stability of the country’s financial system against its fight against stubbornly high inflation. After all, rising interest rates increases the cost of capital and can deter business from borrowing and investing to expand their operations. Rising interest rates can also hinder earnings growth. So again, there’s more to take into consideration than just interest rates.

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