WASHINGTON – Federal Reserve officials face their biggest challenge in months as they weigh whether to keep raising interest rates this week to cool inflation, or take a pause amid the market turmoil fuelled by recent bank failures.

Before the collapse of Silicon Valley Bank and the resulting fallout, Fed policymakers were poised to raise rates by as much as 50 basis points after a string of data suggested that the economy was much stronger than officials thought at the beginning of the year.

Now, given the financial market volatility, many Fed watchers expect a smaller, quarter-point increase, and some say the United States central bank will pause altogether after a two-day meeting that starts on March 21. 

The decision follows a 50 basis-point rate hike from the European Central Bank (ECB) on Thursday. ECB president Christine Lagarde said the central bank remains committed to fighting inflation, while monitoring bank tensions closely.

Also highly anticipated from the Fed meeting will be an update to its summary of economic projections – a quarterly report laying out participants’ forecasts for everything from inflation to interest rates – and Fed chair Jerome Powell’s post-meeting press conference.

Amid the banking sector turmoil, Mr Powell will likely face questions around the central bank’s supervision of SVB and other struggling entities. 

He will also need to tread carefully when talking about the likely future path of interest rates. Before the banking issues emerged, Fed officials indicated that rates will need to move above 5 per cent this year and remain there until inflation is on pace to fall back to their 2 per cent target. 

Yet, heightened uncertainty over to what extent bank capitalisation issues – exacerbated by the Fed’s rapid interest rate increases and the impact on Treasury yields – will impact the broader economy may limit Mr Powell’s ability to tighten much more. BLOOMBERG