It was considered a foregone conclusion that the US Federal Reserve would initiate a turnaround in interest rates. Now it is clear that it has decided to take a big step.
The US Federal Reserve is changing course and lowering its key interest rate for the first time in more than four years. In view of the slowing inflation, the Fed decided on an unusually large interest rate hike of 0.5 percentage points. The key interest rate is now in a range of 4.75 to 5.00 percent. Commercial banks can borrow central bank money at this rate.
The central bank is signaling further interest rate cuts this year. Fed decision-makers expect an average key interest rate of 4.4 percent in 2024 (June: 5.1 percent). This indicates another large step of 0.5 percentage points or two small steps of 0.25 percentage points each downward.
Fed Chairman Powell: Our approach has paid off
“Our patient approach over the past year has paid off,” said Fed Chairman Jerome Powell. However, given the high consumer prices, one cannot say “mission accomplished,” said Powell. But the risk of inflation has declined, while the risks on the labor market have increased. That is why it makes sense to lower interest rates.
“Over the past two years, the labor market has cooled down from its once overheated state,” said the head of the central bank of the world’s largest economy. The Fed expects an average unemployment rate of 4.4 percent this year – 0.4 percentage points higher than forecast in June.
Fight against high consumer prices
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 central bank has also published new – very optimistic – 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 companies are more likely to invest and many citizens have to spend less on loans – 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 fierce critic of Fed Chairman 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 Biden’s vice president, Kamala Harris.
Asked about Trump’s comments, Powell said: “Our job is to support the economy on behalf of the American people. And if we do it right, it will benefit the American people, and it will benefit them significantly.” There are no other filters in the central bank meetings. “Once you start doing that, I don’t know where to stop, and that’s why we just don’t do it.”
Source: Stern
