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

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

The minutes of the March meeting of the Federal Open Market Committee included a presentation from staff about the potential fallout from the Silicon Valley bank failure and other financial sector turmoil that began in early March.

Although Vice President for Oversight Michael Barr said the banking sector was “healthy and resilient,” economists said the economy would take a hit.

The summary of the meeting stated that “given their assessment of the potential economic impacts of recent developments in the banking sector, staff expectations at the time of the March meeting included a mild recession beginning later this year, with a recovery over the following two years.” ..

Projections after the meeting indicated that Fed officials expected GDP growth of just 0.4% for 2023. With the Atlanta Fed tracking first-quarter gains of around 2.2%, that points to a slowdown later in the year.

This crisis has caused some speculation that the Fed may remain conservative on interest rates, but officials stressed that more needed to be done to tame inflation.

FOMC officials finally voted to increase the benchmark borrowing rate by 0.25 percentage point, the ninth increase over the past year. This pushed the federal funds rate into the target range of 4.75%-5%, its highest level since late 2007.

The rate hike came less than two weeks after the collapse of Silicon Valley Bank, at the time the 17th largest institution in the United States, in the wake of an outflow of deposits. The failure of SVB and two others prompted the Federal Reserve to create an emergency lending facility to ensure that banks could continue operations.

Since the meeting, inflation data has been mostly in line with the Fed’s targets. Officials at the meeting said they see further price declines.

“Reflecting the effects of the expected less narrowing in the product and labor markets, core inflation was expected to slow sharply next year,” the minutes read.

But concern about broader economic conditions remained high, particularly in light of banking problems. After the collapse of SVB and two other institutions, Fed officials opened new borrowing facilities for banks and eased the terms of emergency loans in the discount window.

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

“Even with the procedures, the participants recognized that there was a great deal of uncertainty about how these conditions would develop,” the record said.

Many policymakers wondered whether to hold interest rates steady while they watched to see how the crisis unfolded. However, they relented and agreed to vote to raise the rate again “because of rising inflation, the strength of recent economic data, and their commitment to bring inflation down to the committee’s long-term target of 2 percent.”

Indeed, the minutes indicated that some members were inclined to raise the interest rate by half a point before the banking problems. Officials said inflation was “extremely high” although they stressed that the data received and the impact of the increases should be taken into account when formulating future policy.

The minutes stated that “many of the participants stressed the need to maintain flexibility and discretion in determining the appropriate position for monetary policy in light of the highly uncertain economic outlook.”

Inflation data was generally in line with the Fed’s targets.

The personal consumption expenditures price index, the most closely watched gauge of inflation by policymakers, rose just 0.3% in February and rose 4.6% year over year. The monthly profit was lower than expected.

Earlier on Wednesday, the consumer price index showed an increase of just 0.1% in March and slowed to an annualized pace of 5%, the latest figure down a full percentage point from February.

However, that Read the CPI address Declined mostly by food and energy prices, increased shelter costs also sent core inflation up 0.4% for the month and 5.6% from a year ago, slightly higher than it was in February. The Fed expects housing inflation to slow during the year.

There was some bad news on the inflation front: A monthly survey from the Federal Reserve Bank of New York showed inflation expectations over the next year increased half a percentage point to 4.75% in March.

Markets as of Wednesday afternoon had identified a 72% chance of another quarter percentage point hike in May ahead of the policy pivot as the Fed cuts before year-end, according to data from CME Group.

Although the FOMC approved an increase in March, it changed the language in a post-meeting statement. Where earlier statements indicated the need for “continued increases”, the committee changed the wording to indicate that further increases “may be appropriate”.