Fed cuts interest rates to 0.25%, signals only two more easings in 2025 and will ‘slow further’ in the long run

After cutting rates by 1 percentage point since September, Fed officials are expected to make just two cuts next year.

At the end of its two-day policy meeting, the Federal Reserve (Fed) decided to cut its key interest rate by 0.25 percentage points. This is the third consecutive cut and the central bank also signaled that it will be more cautious with cuts in the coming years.

Accordingly, as expected by the market, the Federal Open Market Committee (FOMC) cut the overnight lending rate to a range of 4.25% – 4.5%, equivalent to the level in December 2022.

While the market did not react too favorably to the Fed’s decision, the key question is how the Fed will signal its intentions going forward, given that inflation remains above target and economic growth is solid, conditions that are not usually conducive to easing policy.

In addition to the 25 basis point cut, the Fed indicated that the central bank would deliver only two more easings by 2025, according to data from the dot plot, which shows FOMC members’ expectations for future interest rates. The two cuts represent a halving of the forecast since the chart was last updated in late September.

In addition, officials expect to make only two more cuts after that, in 2026 and 2027. Over the long term, the committee projects the neutral rate at 3%, 0.1 percentage point higher than the September chart.

In two consecutive meetings, a FOMC member has dissented. Specifically, Cleveland Fed President Beth Hammack wanted the Fed to keep rates unchanged. In November, Fed Governor Michelle Bowman voted against a rate cut. This was the first time a governor has voted against a rate decision since 2005.

Overall, the language in the Fed’s post-meeting statement remained largely unchanged, except for a tweak related to the “level and timing” of further rate changes, which was slightly different from the November meeting.

The decision to cut rates at its Dec. 18-19 meeting came even as the committee raised its full-year GDP growth forecast to 2.5 percent, half a percentage point higher than in September. However, officials expect GDP growth to slow to a long-term forecast of 1.8 percent in subsequent years.

Other changes to the Summary of Economic Projections include the FOMC lowering its forecast for the unemployment rate this year to 4.2%, while core and core (PCE) inflation are also higher at 2.4% and 2.8%, slightly higher than the September estimate and still above the Fed’s 2% target.

The committee’s decision to adjust interest rates comes as inflation remains above target and the economy is forecast to grow at a 3.2% annual rate in the fourth quarter and unemployment hovers around 4%.

While those conditions still support a Fed rate hike or hold, officials remain wary of keeping rates too high and unnecessarily slowing the economy. Despite solid macro data, a Fed report earlier this month noted that the economy has grown “modestly” in recent weeks, with signs of cooling inflation and slowing job growth.

Chairman Jerome Powell has indicated that the rate cut is an effort to recalibrate policy as financial conditions do not need to be tightened in the current environment.

With this easing decision, the Fed has cut interest rates by 1 percentage point since September. After the September meeting, the Fed took the “unusual” step of cutting by 0.5%, while the central bank usually increases or decreases by a smaller amount of 0.25% to consider the impact of the adjustment.

An Chi/Market Pulse