The Federal Reserve forecasts a mild recession at the end of 2023 due to the banking crisis that will take two years to resolve

By Jeff Fox —

The Federal Reserve considers the banking crisis likely to push the US economy into a recession later this year, according to Federal Reserve documents released Wednesday.

Minutes from the March meeting of the Federal Open Market Committee include a presentation by its staff on the potential fallout from the Silicon Valley Bank bankruptcy and financial sector woes that began in early March.

Although Vice President of Supervision Michael Barr said the banking sector "is strong and resilient," economists on the committee said the economy will suffer.

“Given their assessment of the potential economic effects of recent events in the banking sector, the staff projection at the time of the March meeting included a

with a recovery in the following two years. ”, noted the summary of the meeting.

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Post-meeting projections indicated that Federal Reserve officials expected gross domestic product growth of just 0.4% for the full year of 2023. Given that the Atlanta Fed forecasts first-quarter GDP growth of 2.2 %, that would indicate a setback at the end of the year.

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The banking crisis sparked speculation that the Federal Reserve would avoid further interest rate hikes, but its officials stressed that more needed to be done to control inflation.

The members of the Federal Open Market Committee voted in favor of increasing the reference interest rate by a quarter of a percentage point.

With this, the federal funds interest rate was between 4.75% and 5%, its highest level since the end of 2007.

The rate hike came less than two weeks after the failure of Silicon Valley Bank, at the time the 17th largest bank in the country, following a spate of deposit withdrawals.

The bankruptcy of SVB and two other entities led the Federal Reserve to create emergency lending mechanisms to ensure that the banks could continue to operate.

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Since the meeting, inflation data has been largely cooperative with the Fed's targets. Officials said at the meeting that they expect prices to continue to decline.

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

But concerns about general economic conditions remained high, especially in light of the banking problems.

After the bankruptcy of SVB and two other entities, the Federal Reserve opened a new line of credit for banks and eased the conditions for emergency loans at the discount window.

The minutes say the programs helped the sector overcome its problems, but officials said they expect lending to tighten and credit conditions to deteriorate.

"Even with the measures taken, the participants acknowledged that there was great uncertainty about how these conditions would evolve," the minutes state.

Half a point rise if not for the crisis?

Several policy makers wondered if they should hold rates steady as they watched the crisis unfold.

However, they relented, agreeing to vote for another rate hike “due to high inflation, the strength of recent economic data, and their commitment to bring inflation down to the long-term target of 2% set by the committee.” .

In fact, the minutes show that some members favored a half-point rate hike before the banking problems.

The officials said that inflation is “too high”, although they stressed that incoming data and the impact of increases will have to be taken into account when formulating future policy.

"Several participants stressed the need to maintain flexibility and optionality in determining the appropriate stance of monetary policy, given the great uncertainty of the economic outlook," the minutes state.

Inflation data has generally been cooperative with the Fed's targets.

The personal consumption expenditures price index, which is the inflation indicator most closely watched by policy makers, rose just 0.3% in February and 4.6% annualized.

The monthly increase was lower than expected.

On Wednesday, the consumer price index registered an increase of only 0.1% in March and slowed to an annual pace of 5%, the latter figure one percentage point less than in February.

However, the headline CPI reading was held back mainly by moderating food and energy prices, and rising housing costs pushed core inflation up 0.4% in the month and 5.6% on compared to a year ago, slightly above the level of February.

The Federal Reserve expects housing inflation to slow throughout the year.

There was bad news on the inflation front: A monthly survey by the New York Federal Reserve showed that inflation expectations for next year rose half a percentage point, to 4.75%, in March.

According to CME Group data, markets on Wednesday afternoon were looking at a 72% chance of a quarter-point rate hike in May, ahead of a turnaround in the Federal Reserve's cut policy ahead of the end of the year. of year.

Although the Federal Open Market Committee approved a hike in March, it changed the language of the post-meeting statement.

Where previous statements referred to the need for "continued hikes," the committee changed the wording to indicate that further hikes "may be appropriate."