It was considered a given that the US Federal Reserve would initiate a change in interest rates. It was unclear how large the interest rate hike would be. Now it is clear that the US Federal Reserve has decided on the bolder approach.
The US Federal Reserve is reacting to the slowdown in inflation and is lowering its key interest rate for the first time in more than four years. The Fed reduced the interest rate on Wednesday by 0.5 percentage points to a range of 4.75 to 5.00 percent. Commercial banks can borrow central bank money at this rate. This is an unusually large interest rate move – the central bank is also signaling further interest rate cuts this year.
The change of course towards a looser monetary policy was expected – but it was unclear whether the central bank of the world’s largest economy would opt for this major jump in interest rates – or take the more cautious path and only lower interest rates by 0.25 percentage points.
Interest rate turnaround initiated
The Fed last lowered the key interest rate in March 2020 – to stimulate the economy in the early stages of the corona pandemic. After that, interest rates initially remained at zero – until the Fed began raising rates at a record pace in March 2022 and raised the interest rate to its current level a year ago. In the US, price increases have recently weakened. This gives the Federal Reserve more room for maneuver to cut interest rates. The European Central Bank had already initiated the interest rate turnaround in June.
The Fed’s new economic forecast now indicates that the central bank is likely to lower interest rates even further this year. The Fed’s decision-makers are expecting an average key interest rate of 4.4 percent for this year (June: 5.1 percent). For the coming year, the Fed is expecting an average key interest rate of 3.4 percent (June: 4.1 percent).
Fight against high consumer prices
The central bank has also published new forecasts for the inflation rate. This year, the Fed is expecting a lower inflation rate than forecast in June – it should average 2.3 percent (June: 2.6 percent). For the coming year, the central bankers are expecting an average of 2.1 percent (June: 2.3 percent). The US Federal Reserve is aiming for an inflation rate of 2 percent in the medium term.
However, core inflation, i.e. excluding food and energy prices, is expected to be 2.6 percent this year (June: 2.8 percent) and 2.2 percent next year (June: 2.3 percent). The central bankers are paying particular attention to this value in their analysis. Experts believe that it reflects the general price trend better than the overall rate, as components susceptible to fluctuations are factored out.
Balancing act for Fed
The Fed’s monetary policy is only taking effect with a delay – the central bankers are likely to continue to keep a close eye on the inflation rate. For the Fed, the fight against high consumer prices is a balancing act. If interest rates are too high, there is a risk of a recession. If interest rates are cut too early, the inflation rate could rise again. In the summer of 2022, it was more than 9 percent.
A reduction in interest rates makes loans cheaper, which means that companies can invest more easily and many citizens have to spend less on debt – they therefore have more income available. This could stimulate the economy. High returns for savers, on the other hand, could be reduced. Interest rate cuts are good news for US investors. The interest rate cut is likely to weaken the dollar further – travelers to the USA from Germany should be happy about this.
Monetary policy also plays a role in the election campaign
The Fed’s decision comes a few weeks before the presidential election on November 5. The rapid inflation triggered by the rise in energy prices following the Russian attack on Ukraine and the consequences of the corona pandemic has put a strain on the presidency of US President Joe Biden. Many everyday products are more expensive than during Donald Trump’s term in office.
The Republican, a sharp critic of Fed Chairman Jerome Powell, had already tried to politicize the interest rate decisions. He claimed that the Fed should not cut interest rates before the election in November because this would improve the mood in favor of the current administration of Democratic President Biden. Trump is running against US Vice President Kamala Harris in the election.
New economic data
Recently, pressure from the economy on Powell to raise interest rates has grown. One argument for this is the cooling labor market. Opponents of a loose monetary policy, however, say that interest rate cuts are not yet necessary given the robust US economy.
The central bank has now also published its new economic forecast for the USA. The gross domestic product (GDP) of the world’s largest economy will grow by 2 percent in 2024 (June: 2.1 percent). For the coming year, the Fed also predicts growth of 2 percent, the same figure as forecast in June.
Source: Stern
