Federal Reserve cut interest rates by half a percentage point on Wednesday, marking the first time in four years that the central bank had lowered rates.
The Fed has announced that after a two-day meeting in Washington, D.C., its monetary committee will be moving its target rate to a range between 4.75% and 5.00%.
Investors had bet on a Fed rate cut of a lesser magnitude. This was an unusual miscalculation since Fed decisions are usually telegraphed well in advance.
After years of almost frantic attempts by the central banks to stop inflation, the rate cut is a welcome relief. The Fed’s decision on Wednesday signals that they no longer see inflation as a threat, but instead are more concerned about the potential for an economic slowdown or even recession.
Since the beginning of 2024, the Fed has consistently delayed the date when it might cut interest rates. This is because inflation was high during the first half of this year and at times even increased. It was once thought that the Fed would not cut interest rates this year. However, recent data showing that inflation is declining has made it less likely.
The Fed’s long-term goal is 2% inflation. It considers this rate healthy for both the economy and consumers.
The consumer price index is the most commonly cited inflation indicator by the public. The Bureau of Labor Statistics announced last week that CPI inflation fell by four-tenths of one percentage point in August to 2.5%. This marks five months of deflation. CPI inflation has now reached its lowest level since February 20, shortly after Joe Biden’s inauguration.
The Fed also uses the Personal Consumption Expenditure Price Index to measure inflation. According to the latest PCE report, inflation was 2.5% in July. Core PCE inflation – a measure that excludes volatile food and energy prices – remained at 2.6% on a year-over-year basis.
The last time the interest rates were lowered, the U.S. faced a crisis due to the pandemic. Stocks were in freefall and the economy was in recession. The Fed cut rates to near zero and held them there for two years until a surge in inflation forced it to start raising interest rates.
The cut in interest rates is good news for Vice-President Kamala Harris who has been plagued with President Joe Biden’s low economic approval rating and widespread discontent over inflation and high interest.
The Fed’s target interest rate affects every aspect of life. Higher interest rates have pushed up mortgage rates, making it difficult for many voters to buy a house. The higher interest rates have made it more costly to get a car loan or pay back credit card debt.
It will be a marginal relief as it will take time for the Fed’s interest rate target to continue falling.
The Fed is likely to be blamed by former President Donald Trump for this decision. Trump said earlier this year Fed Chairman Jerome Powell was going to try and give Democrats an edge by lowering interest rates. “He won’t be able to do anything,” Trump said that it appeared to him as if he was trying to lower the interest rates to get people elected.
The Fed was able to maintain high interest rates because the labor market remained resilient. There are signs now that the labor markets are softening. This has raised alarms and put pressure on the central banks to cut.
The economy added 142,000 jobs in August, reflecting a downward trend in job creation in recent months. The unemployment rate is now 4.2%, an increase from recent lows of 3.4%. In another sign of cooling, job openings plunged in July to their lowest level since January 2021, when Biden entered office.
The overall economic output, the primary way to track recessions, has been strong this year and even increased.
Bureau of Economic Analysis reported recently that the gross domestic product increased at a rate of 3% annually in the second quarter. This is an increase from the 1.4% growth rate in the first three months of the year.
