WASHINGTON, March 23 (Reuters) - For the first time in a year the Federal Reserve has left its next policy step in doubt as its policymakers weigh the risks of continued high inflation against a possibly looming U.S. credit crunch that could slow the economy in sharp and potentially unexpected ways.
Walking a narrow line that could leave financial markets both unsettled and guessing about what's next, Fed Chair Jerome Powell said in a news conference that U.S. central bank officials will themselves be in the dark until more is known about how banks might change their lending behavior in response to the failure of two regional lenders caught out by unexpected deposit runs.
The Fed raised its benchmark overnight interest rate by a quarter of a percentage point on Wednesday, the ninth straight policy meeting that ended with a rise in borrowing costs since the current tightening cycle began in March 2022. But for the first time since then, it opened the door to a possible pause in the tightening, while keeping its options open for a further increase as well.
"It's really ... a question of not knowing at this point," Powell told reporters after the meeting. "How significant will this credit tightening be, and how sustainable? ... This is 12 days ago," that a pair of bank failures reshaped the financial landscape facing the central bank, with potential implications for the real economy and the path of inflation.
Until the March 10 failure of Silicon Valley Bank the higher- and stickier-than-expected path of inflation had warranted steady Fed rate hikes - a singular focus that shaped the policy views of Powell and his colleagues for much of 2022 and several months into 2023.
But uncertainty about the health of the banking industry has now touched off a scramble by U.S. regulators, lawmakers and politicians to figure out if a broader financial crisis is developing and how to tighten supervision and regulation in response.
For now, Powell said he thought the problems would be contained to California-based SVB and the smaller New York-based Signature Bank, whose failures were deemed a "systemic risk" by U.S. officials and prompted the Fed to rapidly stand up a new lending facility for banks facing unusual withdrawal demands.
Those facilities as well as other programs at the central bank are meant to address financial stability concerns so monetary policy can address inflation, which is still running at more than double the Fed's 2% target.
Data on the first full week of borrowing from that facility will be released on Thursday, followed by data on Friday showing the systemwide changes in bank deposits.
In his news conference, Powell said deposit flows from banks appeared to have "stabilized over the last week," even as U.S. money market funds attracted their biggest weekly inflows in nearly three years.
The political and regulatory situation, however, remains fluid.
The Fed has launched its own review of how supervision of SVB may have broken down and allowed the lender to fail even though regulators had identified problems as far back as 2019.
The U.S. Senate Banking Committee is holding hearings on the bank failures next week. Some lawmakers have proposed legislation to toughen the Fed's oversight.
After raising rates at a record pace over the past year "there is a clear recognition that it may be time to pause," said Rick Rieder, chief investment officer of global fixed income at BlackRock. "The challenges facing the (Federal Open Market Committee) today ... take on a particular aura of complexity." (Reporting by Howard Schneider; Editing by Paul Simao)
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