Federal Reserve hikes interest rates but gives RBA room to pause

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Never waste a crisis. It’s a key tenet of politics, and a playbook the world’s major central banks appear to be following.

Their single-minded focus on defeating inflation now has a competitor — maintaining financial stability.

While many economists divorced from the financial system continue urging central banks to keep aggressively hiking rates to slay inflation, the reality of US bank runs and collapses has forced a rethink.

US Federal Reserve chair Jerome Powell explicitly admitted as much at his press conference after Thursday’s quarter of a percentage point rate hike, which was widely expected to be half a percentage point just a couple of weeks ago.

“We did consider that (a pause) in the days running up to the meeting,” Powell told reporters in a press conference after today’s rate rise decision, referring to a period where the banking crisis threatened to spiral out of control.

“Before the recent events, we were clearly on track to continue with ongoing rate hikes.

“In fact, as of a couple of weeks ago, it looked like we’d have to raise rates over the course of the year more than we’d expected at the time of the December meeting.”

The Fed’s policy of least regret?

Instead, the Fed did a major about-face from its position at its previous meeting that concluded on February 1.


At the last meeting it said: “Ongoing increases in the target range will be appropriate.”

At this meeting it said: “Some additional policy firming may be appropriate.”


But Powell was keen to maintain a link between the US banking crisis and inflation when explaining why the Fed had backed off to a smaller rate rise, and might even be finished hiking.

“Since our previous FOMC (Federal Open Market Committee) meeting, economic indicators have generally come in stronger than expected, demonstrating greater momentum in economic activity and inflation,” Powell said in his prepared remarks.

That would normally be a signal for more aggressive rate rises, but not in the face of a banking crisis of confidence.

“We believe, however, that events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses, which would in turn affect economic outcomes,” the Fed chair continued.

“It is too soon to determine the extent of these effects and therefore too soon to tell how monetary policy should respond.”

The policy of least regret?

A small rate hike to show the Fed is still serious about inflation, but small enough to (hopefully) not create fresh trauma for US banks?

Perhaps a signal to the market that the banking crisis is contained and the Fed isn’t panicking?

With careful management, and some luck, the Fed no doubt hopes that the shock from bank collapses will take some steam out of the economy and inflation, heading off the need for further rate increases, but without sparking a total financial meltdown.

How a US banking crisis could avert an Australian one

Bringing it back home, the Reserve Bank of Australia has talked for some time of a “narrow path” to bring down inflation without a severe economic downturn, read recession.

As a relatively small fish in a big global pond, the RBA is at least somewhat hostage to the waves as its bigger central banking counterparts lob interest rate boulders into that pond, especially the Fed.

The RBA, with a cash rate of 3.6 per cent, is already a long way behind the Fed funds rate of 4.75-5 per cent.

That puts downward pressure on the Australian dollar, which in turn puts upward pressure on the price of imports and thus consumer price inflation.

A pause in US rate rises could do huge favours to an RBA that’s already admitting it’s actively considering doing the same here.

In turn, a pause in rate rises here would do some favours to hundreds of thousands of borrowers rolling off cheap fixed mortgages onto variable rates that are in many cases higher than what they’d been assessed as able to afford.

With about two-thirds of Australian banking tied up in home loans, any mortgage crisis is an existential threat to our banks.

It wouldn’t be the first time a US banking crisis has saved Australia from its own mortgage and potential banking crisis.

The pre-global financial crisis mining boom was the last time in recent history that Australia’s unemployment rate was remotely close to what it is now.

Inflation got to 5 per cent by the September quarter of 2008, while the RBA cash rate target peaked at 7.25 per cent In March 2008.

It probably would have risen even further, as inflation was still climbing, but for the early stages of the global financial crisis.

Australian rates were held steady after US investment banking giant Bear Stearns was bailed out in a takeover by JP Morgan Chase, while share markets fell and the global financial system slowly unravelled on the back of major losses from US subprime mortgages.

But Australian households bursting at the seams with debt and struggling with mortgage rates approaching 10 per cent were ultimately saved by the collapse of Lehman Brothers.

The ensuing global financial crisis saw the RBA slash interest rates by 4.25 percentage points between the start of September 2008 and April 2009.

Throw in some government stimulus payments and first home buyer incentives, plus huge demand for commodities coming out of China’s own stimulus program, and by mid-2009 the Australian economy was saved, famously without recession.

With the largest cohort of cheap, pandemic-era, fixed-rate mortgages rolling off between next month and the end of this year, a US banking crisis and the rate relief it might bring can’t come fast enough for a lot of Australian mortgage borrowers.

By business reporter Michael Janda (Original ABC Article)