Thu. Jul 18th, 2024

US Federal Reserve Signals Limited Interest Rate Cut Despite Easing Inflation

The US Federal Reserve has indicated it will reduce its key interest rate only once this year, despite the easing of inflation. This is a significant shift from March forecasts that had anticipated up to three cuts by the end of 2024.

On Wednesday, Fed officials revealed their new projections, following a decision to maintain current interest rates at their 23-year high, despite a slight decline in inflation. The inflation rate, which tracks the pace of price increases, slowed to 3.3% in the year to May, down from 3.4% in April. However, inflation between April and May remained unchanged and continues to exceed the Fed’s 2% target.

Jerome Powell, Chair of the Federal Reserve, emphasized that only “modest” progress had been made towards achieving the target. He stated that the central bank would need to see more substantial improvements in inflation before considering rate cuts. As a result, US interest rates remain at 5.25%-5.5%.

Anastassia Fedyk, an assistant professor of finance at Haas Business School at the University of California Berkeley, commented on the cautious stance of the Fed in an interview with the BBC’s Today programme. “We did get some good news in terms of better inflation numbers,” she noted. “But the Fed is still being pretty cautious so they are signalling that in the future they are going to be doing one, most likely, rate drop and not a very large one at that.”

Analysts have mixed opinions on the Fed’s approach. Ian Shepherdson, chief economist at Pantheon Macroeconomics, criticized the reduction in forecasted interest rate cuts from three to one this year as “unnecessarily aggressive.” Meanwhile, economists at Wells Fargo suggested it would be a “close call” between making one or two reductions in 2024.

Fed officials were divided on their expectations for interest rate cuts this year. Of the 19 policymakers who provided their outlook, four anticipated no cut, seven forecasted one reduction, and eight expected two cuts. The Fed’s forecasts indicated a modest cut to 5%-5.25%.

Powell acknowledged that such a modest reduction would not significantly impact the US economy but stressed the importance of making a careful decision. “When a cut finally does come, it would be a consequential decision for the economy which you want to get right,” he said.

Despite the easing of inflation, the US job market remains robust. Recent data showed US employers added 272,000 jobs in May, far exceeding the expected 185,000. Ms. Fedyk explained, “The Fed is trying to react to the data but not overreact to the data.”

While other major economies, such as the European Central Bank and the Bank of Canada, have cut interest rates, the US and the UK have not followed suit. The Bank of England is expected to hold interest rates at 5.25% in its upcoming meeting, maintaining the highest level in 16 years.

In the UK, the Consumer Prices Index (CPI) measure of inflation has significantly slowed from a high of 11.1% in October 2022 to 2.3% currently. However, some inflation components remain persistently high, and average wage growth continues to outpace inflation. Ruth Gregory, deputy chief UK economist at Capital Economics, noted that while wage growth remains sticky, other indicators might allow the Bank of England to cut interest rates in August if there is decent progress in areas such as pay settlements and CPI inflation.

As the Federal Reserve navigates the delicate balance between controlling inflation and supporting economic growth, its cautious approach reflects the complexity of the current economic landscape.

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