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The Federal Reserve's battle against inflation may be close to a turning point

LEILA FADEL, HOST:

I'm Leila Fadel in Washington, D.C., where we're watching the Federal Reserve's 14-month battle against inflation.

A MARTÍNEZ, HOST:

Yeah. The central bank is expected to raise interest rates again this afternoon, but forecasters think that could be the last rate hike for a while. Today's meeting comes on the heels of another bank failure, which could complicate the Fed's calculations.

FADEL: NPR's Scott Horsley joins us now to explain.

Good morning, Scott.

SCOTT HORSLEY, BYLINE: Good morning, Leila.

FADEL: So the Fed uses interest rate hikes to regulate inflation, which is still pretty high. Why is the Fed going to push the pause button after today?

HORSLEY: Well, they may. This would be the 10th rate hike in a row for the Fed, and you are beginning to feel the drag of those higher rates on the U.S. economy. The construction and manufacturing sectors, which are particularly sensitive to interest rates, are in a slump. Ordinary people are starting to spend less money. And the job market, although it's still pretty strong, is showing some signs of losing steam. So some observers think it's time for a pause in rate hikes. Lindsay Owens heads the Groundwork Collaborative. That's a progressive think tank here in Washington. She wants the Fed to take a breather and see if inflation continues to settle down.

LINDSAY OWENS: It's not the case that we have to keep hammering away at trying to slow growth in the labor market to bring down inflation. We can have both.

HORSLEY: This has already been the most aggressive series of interest rate hikes since the 1980s, so it's gotten a lot more expensive to borrow money for a business or get a car loan or carry a balance on your credit card. Another increase today would bring the Fed's benchmark rate to just over 5%, and that's about where the average Fed policymaker said rates ought to end up this year.

FADEL: Now, how does the recent turmoil in the banking system affect the Fed's calculations?

HORSLEY: It's definitely something the Fed is watching. Over the weekend, we saw another bank go under, with First Republic. That follows the collapse of Silicon Valley Bank and Signature Bank back in March. In the wake of these failures, other banks are likely to be more cautious about making loans, and so that's another speed bump for the economy. It acts kind of like higher interest rates, but it's not nearly so carefully calibrated.

Economist Ian Shepherdson of Pantheon Macroeconomics thinks the economy and the job market will be significantly weaker because of these bank failures, with an outright loss of jobs this summer. He wishes the Fed had stopped raising rates sooner, but he thinks they will stop after today.

IAN SHEPHERDSON: I do think that's the last one, and then things begin to change in June and finally in September. And as far as I'm concerned, the sooner the better.

HORSLEY: By this fall, Shepherdson thinks the central bank will be forced to start cutting interest rates. Now, the Fed's own forecasts do not indicate that. On average, policymakers expect rates to go a little bit higher today and then hold steady for the rest of the year.

FADEL: Now, Scott, how much of the trouble in the banking sector stems from the Fed's own actions?

HORSLEY: Well, they're certainly related. Some banks, like Silicon Valley, were caught off guard by the rapid rise in interest rates. Of course, banks are supposed to prepare for that possibility, so that's mainly the fault of the bank's own management. But the Fed did issue a scathing report last week, saying its own supervisors had failed to properly monitor Silicon Valley Bank, and that was a factor in the bank's collapse. Fed supervisors were slow to spot problems at the bank. And when the problems were identified, supervisors didn't act aggressively enough to make sure they were corrected.

Michael Barr, who is the top bank regulator at the Fed, blamed some of that on a policy choice that was made in 2019 to exempt all but the biggest banks from strict scrutiny, as well as a culture of light-touch regulation at the Fed, and he promised more aggressive bank oversight going forward. Fed Chairman Jerome Powell endorsed Barr's recommendation, and I suspect the chairman will get some questions about that during his news conference this afternoon.

FADEL: NPR's Scott Horsley.

Thanks, Scott.

HORSLEY: You're welcome. Transcript provided by NPR, Copyright NPR.

Leila Fadel is a national correspondent for NPR based in Los Angeles, covering issues of culture, diversity, and race.
Scott Horsley is NPR's Chief Economics Correspondent. He reports on ups and downs in the national economy as well as fault lines between booming and busting communities.