Fed chairman Jerome Powell assured that banks are in good shape after raising interest rates by 0.25%. Fear among analysts keeps mounting.
The United States Federal Reserve increased interest rates by 0.25% on Wednesday. It is the 9th time in a row interest rates are raised, following a trend that started exactly one year ago. The last time this happened was in January, while the economy was in good shape. Now, however, there are fears of a banking failure and a new 2008 crisis.
The Federal Reserve has pursued this strategy of interest rate hikes in an attempt to fight off inflation. Last March, inflation in the US and Europe was at its highest in 40 years, reaching double digits in some countries.
The Fed, as well as its European counterpart, the ECB, was determined to bring inflation to the target level of 2%. Now, US inflation is at 6.04%, better than last year but far from the target level.
However, analysts feared that interest rate hikes would bring the global economy to a grinding halt. This fear, fueled by the energy war caused by the war in Ukraine, seemed for a while to be unsubstantiated.
In January, the Fed showed signs of optimism by hiking rates at a slower pace than usual. Meanwhile, unemployment was at historically low levels and American GDP in 2022 actually grew more than expected.
Everything was going fine. Then a bank collapsed.
The end of optimism
Behind the scenes, interest rate hikes were giving hard headaches to banks. Their liquidity was reducing, they could not pay their assets back. Eventually, the rope snapped.
Two major US banks, Signature and Silicon Valley Bank, collapsed in a matter of few days between each other. Though part of this collapse is also attributable to human error within the institution, it sent shock waves across the entire global banking system.
Governments were worried that panic would lead people to withdraw money from the banking institutions, therefore crashing the entire system down. To avoid a new 2008 crisis, central banks and governments started issuing liquidity.
In raising interest rates again yesterday, Fed chairman Jerome Powell said that “The U.S. banking system is sound and resilient”. “Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation,” he continued. “The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks.”
But the optimism that prevailed earlier this year has been conclusively turned into fear. And this further interest rate hike cannot be good, even if it is the last one.
The only option is that banks will be bailed out until inflation is finally over and interest rates start coming down again. But if there is not enough liquidity to do so, a recession might actually be unavoidable.
