The Federal Reserve reduced its key interest rate by a quarter-point on Wednesday, marking its third rate cut of the year. However, the central bank also signaled that it expects to slow the pace of rate cuts in 2025 due to ongoing concerns about elevated inflation. The Fed’s new projections suggest only two rate cuts in 2025, down from four previously anticipated in September. This change indicates that borrowing costs may not decrease as significantly next year, potentially impacting mortgages, auto loans, credit cards, and other forms of borrowing.
Fed officials indicated that the decision to slow rate reductions comes as the benchmark interest rate nears a “neutral” level — one that neither stimulates nor hinders economic activity. After the quarter-point cut, the Fed’s key rate now stands at 4.3%, following a larger half-point reduction in September and another quarter-point cut last month.
Fed Chair Jerome Powell explained that the slower pace of cuts reflects persistently high inflation and the expectation that inflation will remain above the Fed’s 2% target in 2025. He emphasized that the central bank is approaching the neutral rate, which leads to a more cautious approach to further cuts.
This year’s rate cuts are a reversal of the previous two years of higher rates, which were aimed at taming inflation but also made borrowing more expensive for consumers. Now, the Fed is facing challenges in balancing inflation control with economic growth. Inflation remains sticky, with core inflation — which excludes volatile items like food and energy — at 2.8% in October, still above the target.
At the same time, the economy continues to grow briskly, suggesting that higher interest rates have not significantly restrained economic activity. Some economists and Fed officials have argued that further rate cuts could risk overheating the economy and reigniting inflation. On the other hand, the pace of hiring has cooled, raising concerns over job growth, which is also a key priority for the Fed.
“We don’t think we need further cooling in the labor market to get inflation below 2%,” Powell said, noting that the unemployment rate, although still low at 4.2%, has risen by nearly a full percentage point over the past two years. This uptick in unemployment contributed to the Fed’s decision in September to implement a larger-than-usual half-point rate cut.
The Fed’s new economic projections show that overall inflation is expected to rise slightly from 2.3% to 2.5% by the end of 2025, still well below the peak of 7.2% in June 2022 but not low enough to justify aggressive rate cuts. Additionally, the unemployment rate is projected to edge up to 4.3% by the end of 2025.
While most central banks around the world are also cutting rates, the Fed is taking a more cautious approach. For example, the European Central Bank recently lowered its key rate to 3%, and the Bank of Canada also reduced its rate by a quarter-point last week.
In a rare move, Beth Hammack, president of the Federal Reserve Bank of Cleveland, dissented from Wednesday’s decision, preferring to keep rates unchanged. It was the first dissent by a Fed committee member since September.
As the Fed navigates the uncertain economic landscape, markets and consumers alike will be closely watching how these rate cuts and projections impact the broader economy in the coming year.
