Federal Reserve Eases Interest Rates: Finally

After the Federal Reserve System of the United States (Fed) sharply lowered interest rates, markets reacted almost unanimously: the euro, oil, and stocks rose, while gold slightly decreased after its recent record growth. This is the first rate cut in four years. The general statement from the members of the Federal Open Market Committee (FOMC), which approves such decisions, is filled with declarations of further intentions to reduce inflation to the desired 2% annually, while also maintaining sufficient employment levels. Fed Chairman Jerome Powell promises further rate cuts if conditions permit. In other words, the show must go on, as central banks race to cut the interest rates they were forced to raise sharply from 2022 to combat runaway inflation.

The decision for a significant reduction (a half-percentage point cut) was made by the FOMC with an overwhelming majority of 11 out of 12 votes. Only one vote favoured a smaller cut of a quarter-point. It seems bold and powerful. However, back in December 2023, the plan was to reduce rates gradually in 2024, with three cuts of a quarter-percentage point each. Of course, these were not commitments, but there was talk of reaching 4.5-4.75% by the end of 2024. In fact, these levels have almost been reached with just one cut – Fed rates now stand at 4.75-5%.

This was the first rate cut since April 2020 when the Fed lowered them almost to zero to stimulate the economy during the COVID-19 pandemic. Rates then remained stable until February 2022. From July 2022 onwards, there was a rapid increase, as annual inflation in the US peaked at 9.1% in June 2022 – the highest inflation in 40 years. Overall, in 2022, the Fed raised rates by 4 percentage points, and in 2023, it continued to raise them until they reached 5.33% in August. The Fed maintained rates at this level until September 2024. In essence, the Fed spent nearly four and a half years either raising or maintaining rates unchanged in its meetings.

The Rate Race

This was a global issue – for example, inflation in the eurozone reached 10.6% in October 2022. The maximum inflation rate for the British pound was also recorded in October of that year, at 11.1% annually. Central banks raised rates at the time. However, this was a necessary but undesirable decision, as it had the side effect of slowing down the economy.

So, as soon as inflation began to ease even slightly, central banks started to reduce rates. For instance, the European Central Bank (ECB) cut its rates for the first time by a quarter-point in June, and on 12 September, the ECB Governing Council made another rate-cut decision by a quarter-point, effective from 18 September. In the end the ECB lowered the so-called deposit rate to 3.5% annually.

As we can see, the Fed followed suit, though it had previously hinted multiple times that it would lower rates. In its statement, the FOMC clearly indicated what would follow. Specifically, it stated: "The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance. The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate." As of the end of August 2024, US inflation was 2.5%, down from 3.4% at the end of December 2023. The highest rate in 40 years, as mentioned earlier, was 9.1% in late June 2022. Therefore, significant progress has been made, giving the Fed room to manoeuvre.

The rate-cut race continues – on 19 September, the Bank of England held its rate at 5% annually after reducing it by a quarter-point on 1 August. Previously, this rate had been at a peak of 5.25% since August 2023. Before that peak, the Bank of England had consistently raised its rate from 0.1% – the first increase occurred in December 2021. As we can see, the Bank of England is acting almost in sync with the Fed, while the ECB is slightly ahead.

Consequences of the Fed's Rate Reduction

The euro slightly strengthened after a minor correction. Oil prices rose slightly after a drop on the global market. Stock markets in both the US and Europe began to rise. Gold decreased somewhat, but it appears to be a correction after a dramatic increase earlier. Cryptocurrency values rose significantly.

With 1.5 months remaining before the US presidential election, the Fed's significant rate cut is likely to impact the state of the American economy during this period, particularly in terms of employment. Objectively, the rate reduction decision should support the current White House administration.

Further Reductions Expected

Fed officials have anticipated further rate cuts by another half-point by the end of 2024, followed by a one-point cut in 2025 and an additional half-point cut in 2026. However, they have also issued a caution that these plans could change if conditions do not allow for this schedule. After all, the outlook for the distant future is undoubtedly uncertain.

Investment bank analysts mostly predict two cuts of a quarter-point each at the FOMC meetings in November and December. However, there are even more radical forecasts suggesting a total cut of three-quarters of a point at the mentioned meetings. Therefore, it is entirely possible that the Fed's current 4.75-5% rate will be reduced to 4.0-4.25% by the end of the year, or at the very least to 4.25-4.5%.