Fed cuts rates, but plans fewer cuts next year

The Federal Reserve cut its benchmark interest rate by a quarter point on Wednesday – its third cut this year – but also signaled that it plans to cut rates next year more slowly than it had previously. previously envisaged, largely due to continued high inflation.

The Fed’s 19 policymakers plan to cut their key rate by a quarter point just twice in 2025, down from their September estimate of four rate cuts. Their new projections suggest that consumers may not benefit from much lower rates next year on mortgages, auto loans, credit cards and other forms of borrowing.

Fed officials have stressed that they are slowing their rate cuts as their benchmark rate moves closer to a level that policymakers describe as “neutral” — a level that should neither boost nor hinder the economy. Wednesday’s projections suggest policymakers might think they’re not far from that level. Their benchmark rate stands at 4.3% after Wednesday’s decision, which follows a sharp cut of half a point in September and a quarter of a point last month.

“I think a slower pace of (rate) cuts really reflects both the higher inflation numbers we’ve had this year and the expectations that inflation will be higher” in 2025, said President Jerome Powell during a press conference. “We are closer to the neutral rate, which is another reason to be cautious about further developments.”

The Fed’s rate cuts this year marked a reversal after more than two years of high rates, which did much to keep inflation in check but also made borrowing extremely expensive for U.S. consumers.

But today the Fed faces many challenges as it seeks to achieve a “soft landing” for the economy, whereby high rates would curb inflation without causing a recession. Chief among them is that inflation remains sticky: According to the Fed’s preferred gauge, annual “core” inflation, which excludes the most volatile categories, was 2.8% in October. This figure still remains above the central bank’s 2% target.

At the same time, the economy is growing rapidly, suggesting that rising interest rates haven’t really dampened the economy. As a result, some economists — and some Fed officials — have argued that borrowing 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, which could be concerning because one of the Fed’s mandates is to achieve maximum employment.

“We don’t think we need further cooling in the labor market to bring inflation below 2%,” Powell said at his news conference.

The unemployment rate, while still low at 4.2 percent, has increased by almost a percentage point over the past two years. Concern over rising unemployment contributed to the Fed’s decision in September to cut its key rate by a larger half-point than usual.

Additionally, President-elect Donald Trump has proposed a series of tax cuts – on Social Security benefits, tips and overtime – as well as loosening regulations. Collectively, these measures could boost growth. At the same time, Trump has threatened to impose various tariffs and carry out mass expulsions of migrants, which could accelerate inflation.

Powell and other Fed officials said they would not be able to assess how Trump’s policies might affect the economy or their own rate decisions until more details are available and it becomes clearer how likely it is that the President-elect’s proposals will actually be implemented. promulgated. So far, the presidential election result has only increased uncertainty surrounding the economy.

“I have less conviction about what is going to happen with the economy over the next 12 months than I have in years,” said Subadra Rajappa, head of U.S. rates strategy at the Firm. General. “This is going to be a work in progress as things evolve.”

This uncertainty was highlighted by the quarterly economic projections released Wednesday by the Fed. Policymakers now expect headline inflation, as measured by their preferred indicator, to rise slightly from 2.3% currently to 2.5% by the end of 2025. Inflation according to their measure is now well below its peak of 7.2% in June 2022. Even so, the prospect of slightly higher inflation makes it harder for the Fed to reduce borrowing costs, as interest rates high constitute its main weapon against inflation.

Officials also expect the unemployment rate to rise slightly by the end of next year, from the current 4.2 percent to a still-low 4.3 percent. This slight increase alone may not be enough to justify further rate reductions.

Most other central banks around the world are also cutting their benchmark rates. Last week, the European Central Bank cut its key rate for the fourth time this year, from 3.25% to 3%, as inflation in the 20 countries that use the euro fell to 2.3 % after a peak of 10.6% at the end of 2022. The Bank of Canada also cut its rate by a quarter of a point last week, as did the Bank of England last month.

Beth Hammack, president of the Federal Reserve Bank of Cleveland, opposed Wednesday’s Fed decision because she preferred to keep rates unchanged. This is the first dissent from a Fed committee member since September.