Is the Federal Reserve Running Out of Reasons To Cut Interest Rates?

While the Federal Reserve is widely expected to cut its key interest rate next week, stubborn inflation in could pressure the central bank to keep further cuts few and far between next year.

The inflation rate headed in the wrong direction in November, according to a report on the Consumer Price Index Wednesday, although the data was in line with expectations. The CPI annual inflation rate rose for a second month in a row, to 2.7% from 2.6% in October, and still above the central bank’s goal of 2%.

Financial markets are betting the Fed will go ahead and cut its benchmark interest rate next week anyway, as Fed officials have indicated they would. There was a 95% chance of a rate cut at the Fed’s meeting next Wednesday, according to the CME Group’s FedWatch tool, which forecasts rate movements based on fed funds futures trading data.

Before cutting the fed funds rate in September and again last month, the Fed had held its rate at a two-decade high for more than a year to cool the economy and quash inflation. A rate cut, which influences interest rates on all kinds of loans, would encourage borrowing by businesses and individuals and bolster the economy. The Fed is trying to balance the sometimes contradictory goals of keeping the job market strong while preventing inflation from reigniting.

The Fed Could Trim Rate-Cut Expectations

Fed officials have indicated they’re confident inflation is on a path toward a 2% annual rate, while acknowledging it’s been a “bumpy” ride back down to typical pre-pandemic inflation levels. The last time policymakers made economic projections in September, the median forecast called for the fed funds rate to be in a range of 3.25% to 3.5% next year, compared to the current range of 4.50% to 4.75%, suggesting four quarter-point rate cuts next year.

The recent round of stubborn inflation data could spur the Fed to dial back those expectations. The Fed’s policy committee is scheduled to release another set of economic projections when it meets to set interest rates next week.

“The lack of meaningful progress on inflation means that in their summary of economic projections officials are likely to signal just three rate cuts in 2025 versus the four they projected in September,” James Knightley, chief international economist at ING, wrote in a commentary.

While a rate cut in December is seen as nearly a sure thing, the central bank may hold off on further cuts until inflation resumes its downward trajectory.

 “The Fed will need to see more improvement on the inflation front in the months ahead, if its plan for a steady pace of additional rate cuts next year is to be fulfilled,” Scott Anderson, chief U.S. economist at BMO Capital Markets, wrote in a commentary.

Signs That Inflation Could Cool

Beneath the discouraging overall inflation figures in November’s report, there were some hints that price increases could cool down in the coming months.

For example, housing costs, a major source of inflation pressure, rose 0.3% in November, down from 0.4% in October. Plus, the job market is cooling, with employers pulling back on job openings in recent months, diminishing the chances of rapid wage increases pushing up inflation. And recent data indicates the economy is becoming more productive, which economists say tends to dampen inflation.

“There are numerous reasons why inflation is unlikely to rear its ugly head again, even though there are concerns of another wave,” economists at Oxford Economics wrote. “The labor market isn’t inflationary as the labor market is roughly balanced and nominal wage growth is running consistent with the Fed’s inflation target. Plus, solid trend productivity growth is disinflationary.”

The Uncertain Impact of Trump Policies

Complicating the outlook is the uncertainty about the extent to which incoming president Donald Trump will raise import taxes, as he recently threatened to do. Broad tariffs on foreign goods could stoke inflation and derail the Fed’s plans to gradually lower the fed funds rate to the neighborhood of 3%, the range that officials see as “neutral,” neither stimulating the economy nor hindering it.

Trump’s planned mass deportations of undocumented immigrants could also push up inflation by reducing the labor supply. In that case, the Fed could hold rates higher for longer, putting more upward pressure on interest rates for credit cards, mortgages, and other loans.

“A Fed rate cut next week is likely a done deal, but today’s inflation report could signal an early end to Fed policy easing,” Ronald Temple, chief market strategist at Lazard, wrote in a commentary. “With the incoming Trump administration likely to impose tariffs on imports and significantly tighten immigration policies, prices could re-accelerate further. If that’s the case, December could represent the last cut in the easing cycle.”