Fed Faces Tough Choice on Interest Rates: Inflation vs Financial Stability

Inflation has been a major concern for the Federal Reserve in recent months as the central bank attempts to bring prices back down to its 2% target. The Consumer Price Index (CPI) rose 0.4% in February compared to January and the annual inflation rate was 6%.[0] The core CPI, which excludes food and energy prices, rose 0.5% on the month, up from 0.4% in January, and 5.5% on an annual basis—the highest rate since April 2021.[1] Prices for housing and food led the increase, rising 0.8% and 0.9%, respectively.[2]

The Labor Department also reported a 0.4% decline in retail sales during February from the month before, indicating that consumers are feeling the pinch from higher prices.[3]

Wholesale prices also posted a surprise decline in February, providing some encouraging news on inflation as the Federal Reserve weighs its next move on interest rates.[4] The producer price index fell 0.1% for the month, against the Dow Jones estimate for a 0.3% increase and compared with a 0.3% gain in January.[4] The index rose 4.6% in the span of 12 months, significantly lower than the downwardly revised 5.7% of the prior month.[5]

With the banking sector facing turmoil, driven by the collapse of Silicon Valley Bank and Signature Bank, the Federal Reserve will have to weigh financial stability against inflation when it meets next week to decide on interest rates. Markets are still expecting a 0.25 percentage point increase in the benchmark federal funds rate, but the Fed could be forced into a position where it has to choose between financial stability and taming inflation.

In February 2021, the price of used vehicles – a factor which played an important role when inflation started to rise – decreased by 2.8%, resulting in a year-over-year decrease of 13.6%.[6] For the month, apparel increased by 0.8%, while medical care services costs decreased by 0.7%.[7]

Jerome Powell, Chairman of the Federal Reserve, informed two congressional committees last week that the central bank is prepared to raise interest rates higher than anticipated if inflation does not decrease.[8] This has set off a wave of speculation that the Fed could be teeing up a 0.5 percentage point hike next week.[7]

The Federal Reserve is dealing with the consequences of the SVB collapse, and they may be forced to make a decision between preserving financial security and controlling inflation.

0. “As Inflation Rises, Consumers Shrug at Price Increases” TIME, 14 Mar. 2023, https://time.com/6262763/inflation-high-prices-consumers-cpi

1. “Why slower but stubborn inflation keeps the Fed on track for rate hikes” The Hill, 14 Mar. 2023, https://thehill.com/business/3899251-consumer-prices-rose-6-percent-annually-in-february-as-inflation-eased/

2. “US inflation slows to 6% annual rate amid looming banking crisis” The Guardian, 14 Mar. 2023, https://www.theguardian.com/business/2023/mar/14/us-inflation-slows-banking-crisis

3. “Key inflation measure shows wholesale prices fell last month” CNN, 15 Mar. 2023, https://www.cnn.com/2023/03/15/economy/ppi-producer-inflation-wholesale-prices-february/index.html

4. “Wholesale inflation unexpectedly falls 0.1% in February” Fox Business, 15 Mar. 2023, https://www.foxbusiness.com/economy/wholesale-inflation-unexpectedly-falls-february

5. “Wholesale prices post unexpected decline of 0.1% in February; retail sales fall” CNBC, 15 Mar. 2023, https://www.cnbc.com/2023/03/15/ppi-february-2023-.html

6. “CPI Inflation Rate Still Pretty Hot, But Fed May Pause” Investor’s Business Daily, 14 Mar. 2023, https://www.investors.com/news/economy/cpi-inflation-rate-still-pretty-hot-but-fed-may-pause-sp-500-futures-rise/

7. “Inflation gauge increased 0.4% in February, as expected and up 6% from a year ago” CNBC, 14 Mar. 2023, https://www.cnbc.com/2023/03/14/cpi-inflation-february-2023-.html

8. “The collapse of 2 lenders just made the Fed’s inflation fight harder” NPR, 14 Mar. 2023, https://www.npr.org/2023/03/14/1163129029/the-fed-already-had-a-tough-inflation-fight-now-it-must-deal-with-banks-collapsi