WASHINGTON, D.C. (AP) - The Federal Reserve is poised to raise interest rates for the 10th time on Wednesday. However, two economic trends could complicate and make future rate decisions even more treacherous.
One hand, the turmoil in the banking industry and the political battles about the government's borrowing limits could weaken the country's economy if banks limit lending and the financial markets fall on fear of a nation defaulting on its debt. These fears would be a reason to hold off on further rate increases, at least in the short term.
The Fed may have to tighten credit further to control price rises. The Fed would then have to raise rates again, a trend which would increase borrowing costs and the risk of recession.
Even though they are expected to raise the benchmark rate on Wednesday, to 5,1%, it could cause divisions among Fed officials. The Fed's next move is to signal on Wednesday whether it will pause rate increases, barring a resurgence of inflation. It could also decide to keep the key rate at the same level for the remainder of 2023 while it evaluates its progress towards cooling inflation.
Diane Swonk is the chief economist of KMPG. She said: 'There is clearly some division among Fed officials, which is reasonable given that we do not know where we are and these things are going in a wrong direction.
Austan Goolsbee cited last month the banking turmoil, and the likelihood of many banks tightening credit for consumers and business as reasons to possibly forgo a rate increase this week.
Goolsbee stated, 'I believe we should be cautious'. We should collect more data and not raise rates too quickly.
Patrick Harker warned that too many rate increases could derail the economy.
Other regional Fed bank Presidents, such as James Bullard from the St. Louis Fed or Neel Kazhkari from the Minneapolis Fed have stated that they prefer the central bank to remain steadfast in raising its key rate at least to 5.4%. This would require further rate increases after this week.
This divergence is a reflection of the difficult path the Fed faces. The Fed's support for aggressive and fast rate increases was almost unanimous when inflation spiked to 9.1% in June last year. Unanimity may be more difficult to maintain now that the Fed's key rate has been set at a level which should limit growth, and that inflation has dropped to 5% in March.
The Fed will meet this week in the face of an economic environment that is becoming increasingly gloomy. The nation's financial sector is in turmoil again after the regulators sold and seized First Republic Bank on the weekend. This was the second largest bank failure in U.S. history and the third most significant banking collapse within the last six weeks. Stocks fell sharply Tuesday due to investor concerns that other regional banks could face problems similar First Republic.
Wall Street traders also became unnerved Monday by Treasury Secretary Janet Yellen's announcement that the country could default on its debts as early as June 1, unless Congress agreed to lift the limit before then. The debt ceiling limits how much money the government can borrow. Republicans in Congress want to raise the limit by demanding that spending be cut.
Both of these developments could slow down an economy that is already slowing. The Fed is hoping that the economy will cool down a bit, as less borrowing and more spending should help to control inflation. If the political fights over the debt ceiling intensify, the economy may fall into a recession so deep that the Fed will be forced to lower interest rates this year even if inflation hasn't been fully controlled.
Goldman Sachs believes that a widespread cutback in bank lending this year could reduce U.S. economic growth by 0.4 percent. This could be enough for a recession. The Fed forecast a growth rate of only 0.5% by 2023 in December.
Other major central banks have also been tightening the credit. Christine Lagarde, President of the European Central Bank (ECB), is expected to announce a second interest rate hike on Thursday after Tuesday's inflation data showed that prices increased last month.
In April, consumer prices in 20 countries using the euro currency rose by 7% compared to a year ago. This is up from 6.9% in March.
The core inflation rate in the United States has been chronically high, even though overall inflation rates have fallen as gas prices and the price of many goods have decreased. Core prices increased 4.6% from a year ago, according to the Fed's preferred measurement. This is the same as what happened in December.