MNI: FOMC Agreed Modest Rate Hike Prudent-Minutes

Federal Reserve officials debated a temporary pause to interest rate hikes last month as a banking sector crisis raged but unanimously decided inflation pressures were still sufficiently worrisome to warrant a quarter point interest rate increase, according to minutes of the March meeting released Wednesday.

“Participants noted that recent developments in the banking sector would likely result in tighter credit conditions for households and businesses and weigh on economic activity, hiring, and inflation, though the extent of these effects was highly uncertain. Against this backdrop, all participants agreed that it was appropriate to raise the target range for the federal funds rate 25 basis points,” the minutes said.

The report said “several” Fed officials considered whether it might be appropriate to hold rates steady but decided otherwise.  In contrast, some participants said they might have considered a 50 basis point hike were it not for the banking stress.

Officials were also unanimous in their desire to keep reducing the central bank’s balance sheet by allowing maturing bonds to roll off.

Policymakers are now balancing inflation concerns against worries that the banking turmoil kicked off by the failure of Silicon Valley Bank and Signature Bank could lead to a credit crunch that will put a major dent on economic activity.

“Many participants noted that the likely effects of recent banking-sector developments on economic activity and inflation had led them to lower their assessments of the federal funds rate target range that would be sufficiently restrictive compared with assessments based solely on the recent economic data,” the minutes said.

The Fed's March projections showed FOMC members expected to raise rates once more in this cycle before a pause, and market projections are now aligned with that view. The FOMC's March rate hike brought the fed funds rate target up to 4.75%-5%. 

Policymakers see PCE inflation ending the year at 3.3% and the unemployment rate rising from 50-year lows around 3.5% to 4.5%, according to the March Summary of Economic Projections.  

One major disconnect between markets and the official view is that investors are pricing in fairly aggressive rate cuts from the Fed later this year, while policymakers keep reiterating a "higher for longer" mantra that indicates rates will stay at their peak at least for the remainder of 2023. 

The Fed meeting minutes come as the Labor Department reported another easing in headline CPI to a still elevated 5.0% in March, down from 5.9% in May. Core CPI, however, which Fed officials heed closely as a likely harbinger of future inflation trends, jumped 0.4% on the month for a fourth consecutive month.

Fed officials are still quite worried about price pressures in the service sector in particular. 

"Regarding prices for core services excluding housing, participants agreed there was little evidence of disinflation on this component," the report said.