The Federal Reserve cut its key interest rate by a quarter point on Wednesday – its third cut this year – but also signaled it expects to lower rates more slowly next year than before. Mainly due to still high inflation.
The Fed’s 19 policymakers estimated they would cut their benchmark rate by a quarter point only twice in 2025, down from their estimate of four rate cuts in September. Their new projections show that consumers may not enjoy very low rates for mortgages, auto loans, credit cards and other forms of borrowing next year.
Fed officials have stressed that they are slowing down their rate cuts as their benchmark rate nears what policymakers call “neutral” – a level that is believed to be neither Will accelerate the economy nor hinder it. Wednesday’s estimates suggest policymakers may think they are not too far from that level. Their benchmark rate stands at 4.3% after Wednesday’s move, down from a steep half-point cut in September and a quarter-point cut last month.
This year’s Fed rate cuts mark a reversal after more than two years of high rates, which has largely helped control inflation but also made it more expensive for U.S. consumers to borrow.
balancing inflation and unemployment
But now, the Fed faces a number of challenges as it seeks to accomplish a “soft landing” for the economy, whereby higher rates manage to curb inflation without causing a recession. Chief among them is that inflation remains stable: According to the Fed’s preferred gauge, annual “core” inflation, which excludes the most volatile categories, was 2.8% in October. This is still consistently above the central bank’s 2% target.
At the same time, the economy is growing rapidly, which shows that higher rates have not put much of a dampener on the economy. As a result, some economists – and some Fed officials – have argued that lending rates should not be lowered further for fear of the economy overheating and inflation rekindling. On the other hand, the pace of hiring has slowed significantly since 2024 began, a potential concern since one of the Fed’s mandates is to achieve maximum employment.
The unemployment rate, although still low at 4.2%, has increased by almost a full percentage point over the past two years. The Fed decided to cut its key rate by a larger half-point than usual in September due to concerns over rising unemployment.
In addition, President-elect Donald Trump has proposed several tax cuts – on Social Security benefits, extra income and overtime income – as well as reductions in regulations. Collectively, these steps can stimulate growth. Additionally, Trump has threatened to impose a series of tariffs and mass deportations of immigrants, which could accelerate inflation.
Chairman Jerome Powell and other Fed officials have said they will not be able to assess how Trump’s policies may affect the economy or their own rate decisions until more details become available and it is clear. How likely are the President-elect’s proposals? be enacted. Until then, the outcome of the presidential election has increased uncertainty over the economy.
“I have the least confidence I have in years about what will happen to the economy over the next 12 months,” said Subhadra Rajappa, head of U.S. rates strategy at Societe Generale. “This will remain a work in progress as things develop.”
projections for 2025
Such uncertainty was underlined by the quarterly economic projections released by the Fed on Wednesday. Policymakers now expect overall inflation, as measured by their preferred gauge, to rise slightly from 2.3% to 2.5% by the end of 2025.
Inflation by their measurement is now well below its 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 higher interest rates are its main weapon against inflation.
Officials also expect the unemployment rate to rise to a still-low 4.3% by the end of next year from 4.2%. That modest increase, in itself, may not be enough to justify several more rate cuts.
Most other central banks around the world are also cutting their benchmark rates. Last week, the European Central Bank cut its key rate to 3% from 3.25% for the fourth time this year, as inflation in the 20 countries that use the euro has fallen from a peak of 10.6% in late 2022 to 2.3%. The Bank of Canada also cut its rates by a quarter point last week, as did the Bank of England last month.