The key interest rate in the USA is higher than it has been for more than 20 years. Unlike the monetary authorities in Europe, however, the US Federal Reserve is not planning to reverse interest rates any time soon.
The US Federal Reserve (Fed) is sticking to its high interest rate policy and is only hinting at a rate cut for this year. The Fed left the key interest rate in the range of 5.25 to 5.5 percent for the seventh time in a row, as the central bank council announced in Washington on Wednesday. Commercial banks can borrow central bank money at this rate.
The key interest rate remains at its highest level in more than two decades. New data from the Fed also shows that inflation could prove more persistent than expected.
ECB initiated interest rate turnaround
The European Central Bank (ECB) initiated the interest rate turnaround last week and lowered the key interest rate by 0.25 percentage points. The Fed could take its time with this step. Fed Chairman Jerome Powell said that it could take longer before the Fed has the confidence it needs to start easing monetary policy. “We cannot know what the future holds, but in the meantime we have made pretty good progress on inflation with our current course,” he stressed.
The Fed’s new economic forecast still indicates that the central bank will probably cut interest rates again this year – but only once. In its last two forecasts, the US Federal Reserve had predicted three interest rate hikes of 0.25 percentage points for this year. The Fed’s decision-makers are now expecting an average key interest rate of 5.1 percent for this year (March: 4.6 percent), which indicates an interest rate hike of 0.25 percentage points.
Since March 2022, the central bank has raised its key interest rate by more than five percentage points at a record pace in the fight against inflation. Recently, however, it has stopped raising interest rates. The inflation rate – at more than 9 percent in the summer of 2022, the highest it has been in around four decades – has fallen significantly since the interest rate hikes, and prices are now rising much more slowly. Nevertheless, the Fed’s 2 percent target currently seems out of reach.
Price increases in the USA have weakened somewhat
However, good news came from the US Department of Labor a few hours before the interest rate decision. According to the report, price increases in the US have unexpectedly slowed somewhat. Consumer prices rose by 3.3 percent in May compared to the same month last year. In April, the rate was 3.4 percent. Analysts had expected an unchanged inflation rate for May. The Federal Reserve itself has now also published its economic forecasts – including the estimate for the inflation rate.
These estimates were somewhat more pessimistic, however. The central bank is expecting a slightly higher inflation rate in the USA this year, averaging 2.6 percent (March: 2.4 percent). For 2025, the Fed is assuming an inflation rate of 2.3 percent (March: 2.2 percent). However, core inflation, i.e. excluding food and energy prices, is expected to be 2.8 percent this year (March: 2.6). The central bankers are paying particular attention to this value in their analysis. According to experts, it reflects the general price trend better than the overall rate, as components susceptible to fluctuations are factored out.
Fed Chairman Powell called the inflation forecasts “conservative.” The figures are “good,” but not “great.” However, if there are more positive inflation data from the U.S. Department of Labor in the coming months, the forecast could improve again, Powell said.
However, the US Federal Reserve did not change its economic forecast for the USA. The gross domestic product (GDP) of the world’s largest economy will grow by 2.1 percent in 2024 – as forecast in March. These new figures should reduce the pressure on the Fed to quickly and significantly reduce interest rates. Thanks to the robust growth, the US Federal Reserve can afford to continue to monitor the situation.
US economy surprisingly strong
Central banks raise interest rates to curb demand. If interest rates rise, private individuals and businesses have to spend more on loans – or they borrow less money. Growth decreases, companies cannot pass on higher prices indefinitely – and ideally the inflation rate falls. For the Fed, the fight against high consumer prices is a balancing act. If interest rates are too high, there is a risk of recession. However, the US economy is surprisingly strong despite high interest rates.
Source: Stern
