The Federal Reserve raised its target interest rate by a quarter-percentage point Wednesday while acknowledging that problems in the banking system triggered by its previous rate increases are likely to weigh on the economy.

Why it matters: The Fed is continuing its campaign to bring down inflation through monetary tightening, even as cracks appear in the financial system.

• It is betting that other tools, like emergency lending and deposit guarantees, will contain damage among U.S. banks, and prevent a steep economic slowdown.
• It's also possible that the bank stresses may affect economic activity in a way that would help counter inflation.

What they're saying: "The 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," Fed chair Jerome Powell said at a news conference.

• Powell added it's possible that significant tightening in credit conditions might mean that monetary policy "may have less work to do."

Driving the news: Following a two-day meeting, the policy-setting Federal Open Market Committee raised its federal funds rate target to a range of 4.75% to 5%, the highest it has been since 2007.

• In an accompanying statement, officials did signal more flexibility on what further rate moves might occur, saying that "some additional policy firming may be appropriate."
• That's a contrast with the previous language that "ongoing increases in the target range will be appropriate."

In formal projections, Fed officials' expectations for how the economy will perform and how high rates will rise over the remainder of the year were little changed. The median official expected target rates to rise to 5.1%, the same as previous projections set at the end of last year.

• Notably, none of the officials forecast rate cuts between now and year-end, contrary to moves priced into financial markets that have become more gloomy about the outlook over the last two weeks.

State of play: With inflation still trending far higher than the Fed aims for and the economy proving resilient, the central bank had signaled for weeks that more rate hikes were on the way. As recently as two weeks ago, Powell raised the possibility of an extra-large half-percentage point rate hike.

• However, shortly after that testimony, Silicon Valley Bank was seized by regulators, followed shortly by Signature Bank, prompting fears of a broad run on regional banks across the United States.
• They were undone by losses on longer-term bonds that lost value due to the Fed's aggressive rate hikes over the last year, which triggered depositor flight.
• The Fed and other regulators intervened to guarantee SVB depositors and backstop other banks at risk, aiming to contain the damage.
• Powell on Wednesday said that officials "did consider" pausing interest rate hikes at the latest policy meeting.

Between the lines: The distress in the banking system could cause credit to contract, triggering a recession, slowing demand and bringing down inflation. But it is a fluid, fast-moving, and uncertain situation.

• The Fed is betting that Wednesday's rate hike will help it maintain credibility in its fight on inflation, while maintaining the option of adjusting monetary policy in the future if a bank-induced slowdown does or does not occur.
• Powell tried to thread that needle on Wednesday: "It's possible this will turn out to have very modest effects on the economy and inflation will continue to be strong — in which case the, you know, the [policy path] might look different."

The big picture: The collapse of San Francisco-based SVB has led to a lot of finger-pointing about how regulators acted in the lead-up to the failure.

• News outlets, including Bloomberg and the New York Times have reported that supervisors at the San Francisco Fed raised concerns about how SVB was assessing interest rate risk.
• "The supervisory team was very much engaged with the bank," Powell said at the news conference on Wednesday. The Fed said last week it would conduct a review of the bank's collapse, led by vice chair Michael Barr.

Of note: Wednesday's decision was unanimous, even as commentators outside the central bank have been divided on what the Fed might do next.

Editor's note: This story has been updated with additional details throughout.