The Federal Reserve has indicated that they are planning just one interest-rate cut this year, with more cuts expected in 2025. This decision highlights their strategy to keep borrowing costs high for longer to control inflation.
In their latest meeting, Fed officials unanimously decided to maintain the federal funds rate between 5.25% and 5.5%, a level not seen in two decades. However, they revised their projections, now expecting only one rate cut this year instead of the three they had forecasted in March. For 2025, they foresee four cuts, up from the three previously planned.
Fed Chair Jerome Powell acknowledged recent favorable inflation readings, saying, “We’ve seen some modest progress toward our inflation goal, but we need more good data to be confident that inflation is moving toward 2% sustainably.”
The views among Fed officials on the future of borrowing costs varied. The “dot plot” showed differing expectations: four policymakers predicted no cuts this year, seven anticipated one cut, and eight expected two cuts.
The Federal Open Market Committee updated its language to reflect the recent progress toward their 2% inflation target, a shift from their earlier statements which noted a lack of progress.
Despite these changes, Fed officials emphasized that interest rates are likely to remain high for a longer period, especially after the price pressures experienced in the first quarter. However, they also recognized that inflation showed signs of easing in April and May.
Data released earlier showed a positive trend, with the core consumer price index, excluding food and energy, rising by 0.2% in May and 3.4% over the past year, the slowest increase since 2021. Powell welcomed this data, but said it wasn’t enough to justify rate cuts just yet.
“Rate cuts that could have happened this year will likely occur next year,” Powell explained. “There are fewer cuts expected this year, but we anticipate one more next year.”
In contrast, other countries like the European Central Bank and the Bank of Canada have already started lowering their borrowing costs.
While traders still expect the Fed to cut rates twice by the end of the year, the overall outlook remains cautious.
Fed officials also updated their inflation forecasts, raising the projection for underlying inflation to 2.8% from 2.6% in March. They maintained their forecasts for economic growth and the unemployment rate at 2.1% and 4% respectively, with the unemployment rate rising to 4% in May.
Powell described the labor market as strong but cooling gradually, similar to its state just before the pandemic. He noted, however, that an unexpected downturn could prompt a response from the Fed.
There’s an ongoing debate among Fed officials about whether higher borrowing costs are having the expected impact on slowing the economy. Some, like Dallas Fed President Lorie Logan, believe higher costs may not be as effective, while others, like New York Fed President John Williams, think current policies are on track to bring inflation down.
U.S. central bankers are also discussing whether the neutral rate—the rate at which the Fed neither stimulates nor slows the economy—has increased since before the pandemic. A higher neutral rate would imply that current monetary policy might not be as restrictive as intended.
Powell concluded, “The question of whether policy is sufficiently restrictive will be answered over time. It’s clear that our policy is having the desired effects.”
While U.S. economic growth and spending are slowing, some parts of the economy are showing resilience to higher borrowing costs. For instance, U.S. nonfarm payrolls surged by 272,000 in May, and average hourly earnings growth increased.
The Fed also announced it would continue to reduce its balance sheet at a slower pace. Starting this month, the central bank will allow its Treasury holdings to decrease by up to $25 billion a month, down from the previous cap of $60 billion, while the cap for mortgage-backed securities remains unchanged at $35 billion.