Fed expects banking crisis to cause recession this year, minutes show

WASHINGTON — Fallout from the U.S. banking crisis is expected to tip the economy into recession later this year, according to Federal Reserve documents released Wednesday.

Minutes from the Federal Open Market Committee’s March meeting included a presentation from staff on the potential repercussions of the failure of Bank of Silicon Valley and other turmoil in the financial sector that began in early March.

Although oversight vice president Michael Barr said the banking sector “is strong and resilient,” staff economists said the economy would take a hit.

“Given their assessment of the potential economic effects of recent developments in the banking sector, the staff projection at the time of the March meeting included a mild recession beginning later this year, with a recovery over the following two years,” says the summary of the meeting. .

Projections after the meeting indicated that Fed officials expect gross domestic product growth of just 0.4% for all of 2023, with the Atlanta Fed recording a gain of about 2.2 % in the first quarter, this would indicate a decline later in the year.

This crisis had sparked speculation that the Fed might hold the line on rates, but officials stressed that more needed to be done to get inflation under control.

FOMC officials eventually voted to raise the benchmark borrowing rate by 0.25 percentage points, the ninth increase in the past year. That brought the federal funds rate to a target range of 4.75% to 5%, its highest level since late 2007.

The rate hike came less than two weeks after Silicon Valley Bank, at the time the 17th largest institution in the United States, collapsed following a run on deposits. The failure of SVB and two others prompted the Fed to create emergency lending facilities to ensure banks could continue operating.

Since the meeting, inflation data has been mostly cooperative with Fed targets. Officials said at the meeting that they see prices falling further.

“Reflecting the effects of less expected tension in product and labor markets, core inflation is expected to slow sharply next year,” the minutes said.

But worries about broader economic conditions remained elevated, especially in light of the banking troubles. Following the collapse of the SVB and other institutions, Fed officials opened a new borrowing facility for banks and eased the terms of emergency loans at the discount window.

The minutes noted that the programs have helped the industry through its difficulties, but officials said they expect lending to tighten and credit conditions to deteriorate.

“Even with the actions, participants recognized that there was great uncertainty as to how these conditions would evolve,” the minutes read.

Several policymakers wondered whether to hold rates steady as they watched how the crisis unfolded. However, they relented and agreed to vote for another rate hike “due to high inflation, the strength of recent economic data and their commitment to bring inflation back to the long-term target of 2 % of the Committee”.

In fact, the minutes noted that some members were leaning toward a half-point rate hike before the banking troubles. Officials said inflation was “far too high”, although they stressed that incoming data and the impact of the hikes will have to be taken into account when formulating policy going forward.

“Several participants stressed the need to retain flexibility and optionality in determining the appropriate monetary policy stance given the highly uncertain economic outlook,” the minutes read.

Inflation data has generally been cooperative with Fed targets.

The personal consumption expenditure price index, which is the inflation indicator most watched by policymakers, increased by only 0.3% in February and by 4.6% on an annual basis. The monthly gain was lower than expected.

However, this overall CPI reading was held back primarily by moderating food and energy prices, and an increase in housing costs pushed core inflation up 0.4% for the month and 5.6% from a year ago, slightly above its February level. The Fed expects housing inflation to slow throughout the year.

There was some bad news on the inflation front: a monthly New York Fed survey showed inflation expectations over the coming year rose half a percentage point to 4.75% in March.

As of Wednesday afternoon, markets were attributing about a 72% chance of an additional quarter-percentage-point rise in May ahead of a policy pivot where the Fed would cut before the end of the year, according to data from the CME Group. .

Although the FOMC approved an increase in March, it changed the wording of the post-meeting statement. Where previous statements referred to the need for “continued increases”, the committee changed the wording to indicate that more increases “may be appropriate”.