WASHINGTON — The Federal Reserve has implemented a quarter-point reduction to its benchmark interest rate this Wednesday, marking the third cut within the year. However, it has also indicated a shift toward a more cautious strategy for rate reductions in the upcoming year, largely influenced by persistently high inflation levels.
The Federal Reserve’s 19-member policy board now anticipates only two additional quarter-point rate cuts in 2025, a downgrade from a previous estimate of four cuts made just last month. This change implies that consumers may not experience significantly lower borrowing costs for mortgages, cars, credit cards, and similar loans in the near future.
The initial reaction on Wall Street was one of concern, resulting in a notable decline in stock values, which registered as the worst market performance in four months. The Dow Jones Industrial Average saw a drop exceeding 1,100 points, or about 2.5%. The Nasdaq composite experienced an even more severe downturn of approximately 3.5% on the same day. Higher interest rates typically suppress business growth and expansion.
During a news conference, Federal Reserve Chair Jerome Powell emphasized that the decision to slow down rate cuts is aligned with the benchmark rate approaching what is considered a “neutral” level—one that neither stimulates nor hinders economic activity.
Following the recent rate cut, the current benchmark rate stands at 4.3%. This reduction comes after a significant half-point cut in September and one the previous month. Powell stated, “A slower pace of (rate) cuts reflects the higher inflation readings we’ve had this year, along with expectations of higher inflation in 2025. We are nearing the neutral rate, which also calls for caution regarding future adjustments.”
Blerina Uruci, the chief economist at T. Rowe Price, remarked that Powell’s communication was surprisingly “hawkish,” suggesting a preference for maintaining elevated rates. She pointed out that the decision to implement the quarter-point rate reduction was a closely contested one, as four policymakers advocated for keeping rates steady during this meeting. It’s worth noting that not all members of the Federal Reserve have voting rights at every meeting. One member, Beth Hammack, president of the Federal Reserve Bank of Cleveland, opposed the rate cut in favor of no change.
“The committee may be somewhat divided at this stage,” Uruci suggested. “There seems to be an increasing number of hawkish members.”
Echoing this sentiment, Powell acknowledged that Fed officials are beginning to consider the economic and inflationary impacts of the incoming administration led by Donald Trump. He noted the uncertainty surrounding inflation trajectories as policymakers contemplate potential tariffs and significant immigration reforms proposed by Trump, which could inadvertently exacerbate inflationary pressures in the future.
“It’s logical to proceed with caution when the path ahead is unclear,” Powell explained. “It’s comparable to driving in fog or entering an unfamiliar room—slowing down is a prudent approach.”
The recent cuts in interest rates have marked a notable shift away from a prolonged period of elevated rates aimed at curbing inflation. Now, the Federal Reserve faces several hurdles in striving for a “soft landing” for the economy, which entails mitigating inflation without triggering a recession. A key challenge is the persistent nature of inflation: the latest data indicates that annual “core” inflation, which excludes volatile sectors, was recorded at 2.8% in October, remaining above the Fed’s 2% target.
Conversely, economic growth appears robust, indicating that high rates have not significantly curtailed economic activity. This scenario has led some officials and economists to express concerns that further reductions to borrowing rates could risk overheating the economy, igniting inflation anew.
Simultaneously, the labor market has shown signs of cooling since the beginning of 2024—raising concerns about employment, a mandate closely followed by the Federal Reserve. Powell stated, “We don’t believe further cooling in the job market is necessary to bring inflation below 2%.”
Although the unemployment rate hovers at a low 4.2%, it has witnessed a nearly one-percentage-point increase over the last two years. Concerns over rising unemployment levels were a significant factor leading to the larger-than-anticipated half-point rate cut in September.
When asked about the rationale behind projecting any rate cuts in 2025 given ongoing inflation, Powell highlighted that the Fed anticipates core inflation to decrease to 2.5% next year, categorizing this as a “meaningful improvement.”
He added, “Most forecasters, including ourselves, believe we are on a path to reach the 2% target. However, this may require an additional year or two to achieve.”
Trump’s proposals for various tax reductions and regulatory rollbacks could potentially stimulate growth, yet the threats of imposing tariffs and mass deportations could conversely fuel inflation. Powell confirmed that Fed officials are exploring how these tariffs might affect inflation and the broader economy.
The recent economic projections released by the Federal Reserve highlight this uncertainty, estimating a slight increase in overall inflation—from 2.3% presently to 2.5% by the end of 2025—well below the peak of 7.2% witnessed in June 2022.
Nonetheless, the anticipated rise in inflation complicates the Fed’s ability to reduce interest rates, as these elevated rates are primarily utilized as an instrument against inflationary pressures.
“Moving forward signifies a new phase,” Powell concluded, “and we will proceed with caution regarding any new cuts.”