On Wednesday, the Federal Reserve lowered its key interest rate by a quarter-point, marking its third cut this year. However, it indicated that the pace of future rate reductions will slow in 2025, largely due to ongoing high inflation.
The Fed’s 19-member policymaking committee now predicts that it will implement only two quarter-point cuts in 2025, a decrease from their earlier forecast of four cuts made in September. This adjustment implies that consumers may not see significantly lower interest rates for mortgages, auto loans, credit cards, and other borrowing next year.
The announcement of just two anticipated rate cuts in 2025 unsettled Wall Street, leading to a significant drop in stock prices—the worst market performance in four months. The Dow Jones Industrial Average fell by over 1,100 points, approximately 2.5%, while the Nasdaq composite experienced an even sharper decline of about 3.5%. Elevated interest rates can hinder business growth.
During a press conference, Chair Jerome Powell emphasized that the Fed is adopting a more cautious approach as the benchmark rate approaches what is considered a “neutral” level—an interest rate that neither stimulates nor restricts economic growth.
The latest projections suggest that the Federal Reserve may be nearing that neutral rate, with the benchmark now at 4.3% following the recent quarter-point cut, which came after a half-point reduction in September and another quarter-point cut last month.
Powell remarked, “A slower pace of rate cuts reflects the higher inflation readings we’ve seen this year and the expectation that inflation will remain elevated into 2025. We’re getting closer to the neutral rate, which adds to the need for caution.”
Blerina Uruci, chief economist at T. Rowe Price, characterized Powell’s tone during the press conference as unexpectedly hawkish, suggesting a preference for maintaining elevated rates. She pointed out that Powell noted the decision to cut rates was a closer call, reflecting some dissent among officials. Four members of the committee voted to keep rates unchanged, with one—Beth Hammack, President of the Federal Reserve Bank of Cleveland—opposing the cut entirely.
Uruci commented, “The committee may be quite divided at this point, and there seems to be an increasing hawkish sentiment among members.”
Powell acknowledged that some Fed officials are starting to evaluate the potential impacts of President-elect Donald Trump’s policies on the economy and inflation. He mentioned that certain policymakers believe the election has created greater uncertainty regarding inflation forecasts. Trump’s threats of tariffs on imports and mass deportations could exacerbate inflationary pressures next year.
“It’s just common sense that when the future is uncertain, you proceed with caution,” Powell said, likening it to navigating a foggy road or a dark room.
The Fed’s rate cuts this year represent a shift following more than two years of elevated rates, which successfully kept inflation in check but made borrowing more expensive for consumers.
Currently, the Fed is facing various challenges as it aims for a soft landing for the economy—containing inflation without triggering a recession. A primary concern is the persistence of inflation: The Fed’s preferred measure, annual core inflation (excluding volatile items), stood at 2.8% in October, still above the central bank’s target of 2%.
Conversely, the economy is growing robustly, suggesting that higher interest rates have not substantially restrained it. Consequently, some economists and Fed officials argue against further rate reductions for fear of overheating the economy and reigniting inflation.
Meanwhile, the job market has cooled significantly since the beginning of 2024, raising concerns as one of the Fed’s mandates is to achieve maximum employment. Although the unemployment rate is low at 4.2%, it has increased nearly a full percentage point over the past two years, influencing the Fed’s decision in September to implement a larger-than-usual half-point rate cut.
When asked why any rate cuts are anticipated in 2025 despite persistent inflation, Powell pointed out that the Fed forecasts a decline in core inflation to 2.5% next year, representing substantial progress toward the 2% target. He stated, “That would be significant progress, and we believe we are on a path to reach 2%. It may take another year or two to achieve that.”
Trump’s proposed tax cuts on Social Security benefits, tipped income, and overtime, combined with regulatory rollbacks, could stimulate economic growth. However, his threats of imposing various tariffs and mass deportations could also heighten inflation.
Powell noted that Fed officials are actively trying to understand the potential effects of tariffs on inflation and the broader economy.
The Fed’s uncertainty about future economic conditions was highlighted by the quarterly economic projections released on Wednesday. Policymakers now expect overall inflation, based on their preferred measure, to rise slightly from the current 2.3% to 2.5% by the end of 2025—well below its peak of 7.2% in June 2022.
Nevertheless, the possibility of slightly higher inflation complicates the Fed’s ability to lower borrowing costs, as high interest rates are their main tool for controlling inflation.
“From here, it’s a new phase,” Powell stated, “and we will proceed cautiously regarding additional cuts.”
Source: AP Business
