The Federal Reserve cut its key interest rate by a quarter point. File. | Photo credit: AP
The Federal Reserve cut its key interest rate by a quarter point on Wednesday – the third cut this year – but also signaled that it expects to cut rates more slowly next year than it previously expected, largely due to still high inflation.
The Fed’s 19 policymakers forecast they will cut their benchmark interest rate by a quarter point only twice in 2025, down from their previous estimate of four rate cuts in September. Their new quarterly forecasts suggest that consumers may not enjoy much lower rates on mortgages, auto loans, credit cards and other forms of borrowing next year.
Fed officials have underscored that they are slowing their rate cuts as their benchmark rate approaches a level that policymakers call “neutral” — the level that is seen as neither stimulating nor hindering the economy. Wednesday’s projections suggest policymakers may think they are not far from that level. Their benchmark rate stands at 4.3% after Wednesday’s move, which followed a steep half-point cut in September and a quarter-point cut last month.
This year’s Fed rate cuts have reversed more than two years of high interest rates, which largely helped curb inflation but also made borrowing painfully expensive for U.S. consumers.
But now the Fed faces a variety of challenges as it tries to complete a “soft landing” for the economy, in which high interest rates manage to curb inflation without causing a recession. Chief among them is that inflation remains stubborn: According to the Fed’s preferred measure, annualized inflation was 2.8% in October, the same as in March and still persistently above the central bank’s 2% target.
At the same time, the economy is growing strongly, suggesting that higher interest rates have not slowed the economy much. As a result, some economists – and some Fed officials – have argued that interest rates should not be cut much further, for fear of overheating the economy and reigniting inflation. On the other hand, the pace of hiring has slowed significantly since the start of 2024, a potential concern because one of the Fed’s mandates is to achieve maximum employment.
The unemployment rate is still low at 4.2%, but has risen almost a full percentage point over the past two years. Concerns about rising unemployment contributed to the Fed’s decision in September to cut its key interest rate by a larger-than-normal half point.
In addition, President-elect Donald Trump has proposed a series of tax cuts — on Social Security benefits, tip income and overtime income — as well as a rollback of regulations. Collectively, these steps could boost growth. At the same time, Trump has threatened to impose a variety of tariffs and seek mass deportations of migrants, which could accelerate inflation.
Chairman Jerome Powell and other Fed officials have said they will not be able to assess how Trump’s policies could affect the economy or their own interest rate decisions until more details become available and it becomes clearer how likely it is that the proposals from the newly elected president will do that. are actually entered. Until then, the outcome of the presidential elections had mainly increased uncertainty surrounding the economy.
“I have the least conviction about what will happen to the economy in the next 12 months than I have in years,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale. “This will be a work in progress as things evolve.”
This uncertainty was underlined by the quarterly economic forecasts released by the Fed on Wednesday. Policymakers now expect annual inflation, as measured by their preferred measure, to rise slightly from 2.3% now to 2.5% by the end of 2025. Inflation, according to their measure, is now well below the peak of 7.2 % in June 2022. Still, the prospect of slightly higher inflation makes it harder for the Fed to lower borrowing costs, because high interest rates are its main weapon against inflation.
Officials also expect the unemployment rate to rise slightly by the end of next year, from 4.2% now to a still low 4.3%. That slight increase in itself might not be enough to justify many more interest rate cuts.
Most other central banks in the world are also cutting their interest rates. Last week, the European Central Bank cut its key interest rate for the fourth time this year from 3.25% to 3%, after inflation in the twenty countries that use the euro fell from a peak of 10.6% at the end of 2022 to 2 .3%. The Bank of Canada also cut its interest rate by a quarter point last week, as did the Bank of England last month.
Beth Hammack, president of the Federal Reserve Bank of Cleveland, disagreed with the Fed’s decision on Wednesday, preferring to leave rates unchanged. It was the first dissent from a Fed committee member since September.
Published – 19 Dec 2024 01:13 IST
