The Fed Tries to Thread the Needle on Interest Rates

The Federal Open Market Committee (FOMC) pressed ahead Wednesday with a quarter-point increase to the fed funds rate, bringing the target range to 4.75%-5%. This was less than the half-point increase markets had expected before the recent bank panic, and it came with a softening of the FOMC’s language about possible future rate hikes. The quarterly summary of economic projections by Fed officials released Wednesday still foresees the rate topping out at 5.1% this year, so the rate-rising cycle appears to be one more and done.

That’s out of step with inflation that remains well above the Fed’s 2% target, and the central bank’s prediction that inflation will fall rapidly this year may be too optimistic given its poor forecasting record. As Mr. Powell noted in his press conference, only two weeks ago the price data had signaled higher inflation.

But then came Silicon Valley Bank’s failure and other turmoil that has exposed the threats that rapidly rising rates pose to a financial system distorted by more than a decade of very loose monetary policy. The market pressure on the Fed not to increase rates at all was suddenly intense, so credit the Fed for going ahead despite the lobbying.

Mr. Powell asserted in his press conference that the Fed views inflation and bank turmoil as two separate challenges. He’ll keep using rate increases and a shrinking Fed balance sheet to tame inflation, while relying on supervision and targeted intervention to stave off banking panics. This is the right message to send markets to maintain anti-inflation credibility, while trying to lift confidence that the current financial panic is under control.

Mr. Powell is also betting that the banking ructions will aid the fight against inflation as financial conditions tighten beyond the level implied by the Fed’s monetary policies. This is possible because the coming credit crunch is likely to slow growth.

But it’s also risky. One danger is that the Fed’s lender-of-last-resort activities prove insufficient to control a larger panic if one develops, prompting pressure for a sudden easing no matter the inflation rate at the time. The Fed could be forced to ease before it has conquered inflation.

For now Mr. Powell is hoping he can both calm markets and break inflation. It’s a difficult act, but then the monetary mania followed by inflation and financial panic are problems of the central bank’s creation. That’s why it now has to thread this needle.