WASHINGTON — The Federal Reserve on Wednesday cut interest rates for the first time since the early days of the coronavirus pandemic, cutting the benchmark rate by half a percentage point in an effort to stem a slowdown in the labor market.
With employment and inflation softening, the central bank’s Federal Open Market Committee chose to cut its key overnight borrowing rate by half a percentage point, or 50 basis points, confirming market expectations that had recently shifted away from the prospect of a half-point rate cut.
Aside from emergency rate cuts during the coronavirus pandemic, the last time the FOMC cut rates by half a percentage point was during the 2008 global financial crisis.
The decision lowered the federal funds rate to a range of 4.75%-5%. While the rate sets banks’ short-term borrowing costs, it spreads to a variety of consumer products including mortgages, car loans and credit cards.
In addition to this interest rate cut, the committee also indicated through the “dot plot” that it will cut interest rates by another 50 basis points by the end of the year, which is close to market pricing. Individual officials’ expectations matrices suggest rates will be cut by another percentage point by the end of 2025 and by half a percentage point by 2026.
The statement after the meeting said: “The Committee has increased confidence that inflation will continue to move toward 2% and judges that the risks to achieving the employment and inflation goals are broadly balanced.”
The decision to ease policy “takes into account developments in the balance of inflation and risks.” The FOMC vote was 11-1, with Gov. Michelle Bowman preferring a quarter-point adjustment.
In assessing economic conditions, the committee judged that “employment growth has slowed and the unemployment rate has increased, but remains at a low level.” FOMC officials raised their expected unemployment rate this year to 4.4% from the 4% forecast in their last update in June, and lowered their inflation outlook to 2.3% from the previous forecast of 2.6%. On core inflation, the committee lowered its forecast to 2.6%, down 0.2 percentage points from June.
The committee expects the long-term neutral rate to be around 2.9%, a level that has risen as the Fed works to get inflation down to 2%.
The decision comes despite most economic indicators looking quite solid.
Gross domestic product has been growing steadily, with the Atlanta Fed forecasting growth of 3% in the third quarter based on continued strength in consumer spending. In addition, the Fed chose to cut interest rates even though most indicators showed inflation well above the central bank’s 2% target. The Fed’s preferred indicator shows inflation at about 2.5%, well below its peak but still higher than policymakers expected.
However, Fed Chairman Jerome Powell and other policymakers have expressed concerns about the labor market in recent days. While layoffs show few signs of rebounding, hiring has slowed sharply. In fact, the last time monthly hiring was this low (3.5% of the labor force), the unemployment rate was above 6%.
Powell said at a news conference after the July meeting that a 50 basis point rate cut “is not something we are considering right now.”
For now at least, the move helps resolve a dispute over how aggressive the central bank’s initial move should be.
However, it sets the stage for future questions about what steps the central bank should take before halting rate cuts. Members differed widely in their views on where interest rates will go over the next few years.
In the days leading up to the meeting, investor confidence in the move was shaken. Over the past week, ahead of the decision to cut rates, the odds of a 50 basis point rate cut had shifted to half a percentage point, or 63%, according to CME Group. Fed Watch Indicators.
The Fed last cut interest rates on March 16, 2020, as part of an emergency response to the economic shutdown caused by the spread of Covid-19. In March 2022, as inflation climbed to its highest level in more than 40 years, the Federal Reserve began to raise interest rates. The last increase was in July 2023.
The current unemployment rate is 4.2%, which has increased over the past year but remains at full employment.
With the Fed at the center of the global financial landscape, Wednesday’s decision is likely to reverberate among other central banks, some of which have already begun cutting interest rates. The factors driving higher global inflation are largely related to the pandemic – paralysis of international supply chains, demand for goods over services, and an unprecedented influx of monetary and fiscal stimulus.
The Bank of England, the European Central Bank and the Bank of Canada have all recently cut interest rates, but other central banks are waiting for cues from the Federal Reserve.
Although the Fed approved raising interest rates, it retained a plan to slowly reduce the size of its bond holdings. This process, nicknamed “quantitative tightening,” has reduced the Fed’s balance sheet to $7.2, down about $1.7 trillion from its peak. The Fed is allowing up to $50 billion in maturing Treasury and mortgage-backed securities to be rolled over each month, down from the initial $95 billion at the start of QT.
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