As expected, the US Federal Reserve (Fed) is leaving the key interest rate unchanged at a high level for the fifth time in a row and is continuing to cut interest rates this year. The key interest rate is now still in the range of 5.25 to 5.5 percent, as the Central Bank Council in Washington announced. Commercial banks can borrow central bank money at this rate. The key interest rate remains higher than it has been in more than two decades.
“Inflation is still too high, further progress in reducing it is not certain, and the path forward is uncertain,” warned Federal Reserve Chairman Jerome Powell. Still, the Fed’s new economic forecast continues to suggest the central bank could cut interest rates this year. However, there is much to suggest that this should not start too quickly.
The Fed’s decision-makers expect an average key interest rate of 4.6 percent for this year, as in their last estimate in December. That suggests three rate cuts of 0.25 percentage points each this year. “We believe our key interest rate (…) has probably peaked,” Powell said. If economic data develops as expected, it will “probably be appropriate” to cut interest rates this year, Powell said. However, he made it clear that he wanted to keep the key interest rate at a high level for longer if that was necessary. Analysts assume that the Fed will not begin to tighten interest rates until summer.
Fed expects higher growth
Since March 2022, the Fed has raised its key interest rate by more than five percentage points at a record-breaking pace in the fight against inflation – but has not turned the interest rate screw in the past few months and has left interest rates at a high level. As expected, the Fed’s rapid interest rate hikes had dampened growth in the largest economy. But the US economic data surprised economists – and probably also the central bankers – positively.
The Fed is now predicting significantly higher economic growth this year than expected three months ago. The gross domestic product (GDP) of the world’s largest economy will therefore grow by 2.1 percent in 2024 (December: 1.4). The new numbers are likely to reduce the pressure on the Fed to significantly cut interest rates quickly. Thanks to robust growth, the US Federal Reserve can afford to continue to monitor the situation. The Fed now even expects interest rates to rise slightly in 2025 and 2026 compared to the December forecast as growth and the job market are expected to remain strong.
Price increases in the USA had unexpectedly accelerated somewhat recently – inflation is proving to be stubborn. Consumer prices rose by 3.2 percent in February compared to the same month last year. Analysts on average had expected an unchanged rate of 3.1 percent.
The US Federal Reserve is aiming for price stability of 2 percent in the medium term. The rapid inflation was triggered, among other things, by the rise in energy prices after the Russian attack on Ukraine and the consequences of the corona pandemic. The inflation rate in the USA was always more than 9 percent in the summer of 2022, the highest it has been in around four decades.
Looking for the right balance
Now the US Federal Reserve has published new estimates of inflation. She expects an average inflation rate of 2.4 percent this year. This corresponds to the forecast from December. The Fed expects an inflation rate of 2.2 percent for 2025. Core inflation, i.e. without taking food and energy prices into account, is expected to be 2.6 percent this year (December: 2.4). The central bankers pay particular attention to this value in their analysis. According to experts, it reflects the general price trend better than the overall rate because components that are susceptible to fluctuation are excluded.
Keeping inflation under control is the classic task of central banks. In the fight against high consumer prices, the Fed is increasing interest rates in order to slow down demand. If interest rates rise, private individuals and businesses have to spend more on loans – or borrow less money. Growth is slowing, companies cannot pass on higher prices indefinitely – and ideally the inflation rate is falling. But it is important for the Fed to find the right balance. Because if interest rates are too high, there is a risk of a recession.