Federal Reserve cuts key rate for third time but signals fewer future reductions

The Federal Reserve trimmed its key interest rate by a quarter-point on Wednesday — the third cut this year, signaling that future reductions may occur at a slower pace next year, primarily due to persistent high inflation.

The central bank’s 19 policymakers predict just two benchmark rate cuts in 2025, down from the four anticipated in September. This reduced forecast for rate cuts implies that consumers might not see significantly lower rates on mortgages, auto loans, credit cards, and other borrowings in the coming year.

Wall Street was shaken by the Fed’s projection of only two rate slashes in 2025, leading to a significant drop in stock prices, marking the market’s worst day in four months. The Dow Jones Industrial Average tumbled down over 1,100 points, or approximately 2.5%.

The Nasdaq composite took an even harder hit, plummeting around 3.5% on Wednesday. Elevated interest rates have the potential to decelerate business growth.

Chair Jerome Powell, speaking at a press conference, emphasized that the cutbacks in rate reductions are deliberate as the benchmark rate nears what policymakers consider “neutral”—a rate assumed to neither encourage nor restrict economic growth. After Wednesday’s adjustment, the policymakers seem to believe they may be nearing this “neutral” level.

Currently, the benchmark rate is set at 4.3% following the latest reduction, preceding a sharp half-point decrease in September and a quarter-point cut the previous month.

Jerome Powell, the Federal Reserve Chairman, expressed that the pace of rate reductions might slow down, stating: “I think that a slower pace of (rate) cuts really reflects both the higher inflation readings we’ve had this year and the expectations that inflation will be higher” in 2025. “We’re closer to the neutral rate, which is another reason to be cautious about further moves.”

Blerina Uruci, the chief economist at T. Rowe Price, remarked that Powell’s press briefing came off as surprisingly “hawkish,” signifying a bias towards keeping rates on the higher side. Uruci highlighted a comment from Powell indicating some reluctance about the recent rate cut: “Powell said the Fed’s decision Wednesday to reduce its benchmark rate by a quarter-point was a ‘closer call,’ indicating that there was opposition to the move.”

Indeed, projections revealed that four officials were in favour of not changing the rates at all during the most recent meeting. Not every one of the 19 policymakers votes at each gathering, but Beth Hammack, leader of the Federal Reserve Bank of Cleveland, opposed the rate reduction, preferring to keep rates steady.

“The committee might be quite divided at this point,” said Uruci, noting the emerging hawkish faction within the group. Powell, during his news conference, admitted that some Fed officials are starting to consider how President-elect Donald Trump’s proposed policies could affect economic stability and inflation. He observed that policymaker opinions on future inflation trajectories have become more uncertain post-election.

Trump’s aggressive trade stance through tariff threats and potential mass deportations could add to inflation pressures next year. “It’s kind of common-sense thinking that when the path is uncertain, you go a little bit slower,” Powell remarked. “It’s not unlike driving on a foggy night or walking into a dark room with furniture. Just slow down.”

The Fed’s rate cuts this year have been a shift from over two years of high rates aimed at controlling inflation but also resulted in costly borrowing for American consumers.

However, the Fed now faces several challenges as it attempts to achieve a “soft landing” for the economy, aiming to reduce inflation without triggering a recession. Inflation remains stubbornly high, with the Fed’s preferred measure showing annual “core” inflation at 2.8% in October, above the 2% target.

Despite higher rates, the economy is still growing strongly, leading some economists and Fed officials to caution against further rate cuts due to concerns about overheating the economy and reigniting inflation. Meanwhile, job growth has slowed since the start of 2024, raising concerns because the Fed is also tasked with promoting maximum employment.

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

The Federal Reserve’s decision to reduce its key rate by an unusual half point in September has been linked to rising concerns about unemployment, which, despite being low at 4.2%, has crept up nearly a full percentage point over the last two years. Fed Chairman Powell explained that they are expecting substantial progress on inflation with core rates projected to fall to 2.5% next year.

“That would be significant progress,” he stated, highlighting their aim to eventually reach the 2% inflation target. Powell affirmed: “We’d be seeing meaningful progress to get inflation down to that level.”

Furthermore, Powell reiterated: “We and most other forecasters still feel that we are on track to get down to 2%. It might take a year or two from here.”

President Trump has suggested numerous tax cuts affecting Social Security benefits, tipped income, and overtime pay alongside a rollback of regulations, all potentially boosting economic growth. However, his threats of imposing various tariffs and mass deportations of migrants could have the opposite effect, driving up inflation.

Acknowledging this delicate balance, Powell conceded that the Federal Reserve is actively trying “to understand ways tariffs can affect inflation and the economy and how to think about that.”

The uncertainty of the Federal Reserve regarding the economy’s trajectory has been highlighted by the quarterly economic projections released on Wednesday. The policymakers have adjusted their expectations, now predicting that overall inflation, as measured by their preferred gauge, will edge up from the current 2.3% to 2.5% by the end of 2025, which is substantially lower than the peak of 7.2% seen in June 2022.

However, the anticipation of a slight increase in inflation complicates the Fed’s ability to slash borrowing costs due to high interest rates being its main tool against inflation. Powell emphasised the cautious approach going forward, stating: “From here, it’s a new phase,” and adding, “and we’re going to be cautious about new cuts.”