The US Federal Reserve has started cutting interest rates, and by an unusually large amount. It has lowered the benchmark rate by half a percentage point. What does this mean for the markets and the economy?
The U.S. Federal Reserve (Fed) has cut its benchmark interest rate for the first time since the coronavirus outbreak in response to falling prices. The Fed announced that it would cut the benchmark interest rate by 0.5 percentage points to a range of 4.75% to 5.00%.
It was widely assumed that the Fed would begin a rate turnaround. But how big the rate hike would be was unclear. Many economists had previously forecast a smaller step of a quarter of a percentage point. The cut would mark a turning point in interest rate policy. The Fed has been raising rates at a record pace since March 2022 in the face of stubbornly high inflation, most recently holding rates in a range of 5.25% to 5.50% for more than a year. .
The central bank is closely monitoring the labor market.
But in the United States, the recent weakening of inflation has given monetary authorities more room to cut rates. The European Central Bank (ECB) has already begun a rate turnaround in June.
Regarding the Fed’s dual mandate, Jerome Powell, the central bank’s chairman, noted that progress has been made in combating the inflation wave, so the central bank no longer needs to focus “100 percent” on inflation. In addition to price stability, the central bank must also promote full employment.
What effect do interest rate cuts have on the economy?
Lower interest rates can have many effects on the economy. Lower interest rates make borrowing cheaper, which is attractive to both businesses and consumers. This makes it easier for businesses to invest. Citizens have to reduce their spending on debt, which means they have more income available for consumer spending. Both can stimulate the economy.
The labor market could also benefit from lower interest rates. The recent stagnation in the United States has sparked concerns about a possible recession. Lower interest rates could lead to more investment and consumer spending, which could increase demand for workers.
On the other hand, the dollar is likely to weaken further due to lower interest rates. However, the weaker currency makes it cheaper to export American products, as they can be purchased more cheaply overseas. Conversely, higher import prices could increase domestic consumption.
Impact on the stock market
In the stock market, when interest rates are lowered, the overall stock market tends to rise in the long term, as investors are tempted to take on more risk when safe investments such as government bonds have low yields. The US index, which had been flat until then, rose significantly in direct response to the rate cut.
While interest rate cuts tend to be good news for investors, they are not so good news for American savers who are earning less interest on their deposits.
Balancing Measures for the Fed
For the Fed, fighting high consumer prices is a balancing act. If rates are too high, there is a risk of recession. But if they are cut too early, inflation could rise again. In August, U.S. consumer prices rose just 2.5% from a year earlier. The current inflation rate is lower than it was in February 2021. However, in the medium term, the Fed is targeting a 2% inflation rate.
However, opponents of easy monetary policy argue that there is no immediate need for rate cuts given the robust U.S. economy. Also, core inflation, excluding energy and food, remains at 3.2%, which experts say better reflects overall price trends than overall prices.
Monetary policy during the election year
The decision to cut rates comes at a time when the US election campaign is heating up. Republican presidential candidate Donald Trump has previously urged independent central banks not to start changing rates before the November elections. Fed Chairman Powell has pointed out that the central bank is not a political authority. It will not make monetary policy decisions based on the results of an election that has not yet been held.
President Trump has argued that the Fed should not cut rates before the November election because it would increase his favorability rating for the current Democratic President Biden administration.
What’s next?
Today’s rate cut is likely the starting signal for further Fed easing. The U.S. Federal Reserve announced today that it will cut rates by another half a percentage point this year. Fed officials expect the average rate to be 4.4% this year. And there’s a good chance that another rate cut will be imminent next year. The central bank projects the average rate to be 3.4% in 2025.
The Fed has already said that it will not allow rates to fall below 2% again. Prior to 2022, rates had been below that level for more than a decade.
