Fed lowers key interest rate by another quarter point but sees just 2 cuts in 2025
Paul Davidson, USA TODAY
Updated 8 min read
WASHINGTON – The Federal Reserve lowered its key interest rate by another quarter percentage point Wednesday but forecast a significantly slower pace of rate cuts next year following a recent inflation pickup and strong economic growth.
Officials now foresee only two rate cuts in 2025, down from the four they envisioned in September. Wednesday's move marked the Fed's third consecutive rate cut and brought its benchmark short-term rate to a range of 4.25% to 4.5%. They also predicted sturdier growth, higher inflation, and a more robust job market both this year and in 2025 – an outlook that appears to support fewer rate decreases.
President-elect Donald Trump’s vows to slap hefty tariffs on imports, restrict immigration and cut taxes could be at least partly informing officials’ vision of hotter inflation and growth next year, economists at Barclays and Goldman Sachs said.
Although Fed Chair Jerome Powell has said the central bank isn’t making rate decisions based on uncertain policies, Fed officials could be accounting for Trump’s plans in their individual forecasts, the economists said.
"We just don't know really very much at all about the actual policies, so it's very premature to try to make any conclusion," Powell said at a news conference following the Fed's two-day meeting.
U.S. Federal Reserve Chair Jerome Powell departs after speaking at a press conference where he announced the Fed had cut interest rates by a quarter point following a two-day meeting of the Federal Open Market Committee on interest rate policy in Washington, U.S., December 18, 2024.
Powell acknowledged that some policymakers are factoring in Trump's policies into their estimates of inflation and rate cuts.
"Some people did take a very preliminary step and start to incorporate … highly conditional estimates of economic effects of policies into their forecasts at this meeting and said so in the meeting," Powell said. "Some people said they didn't do so. And some people didn't say whether they did or not. So, we have people making a bunch of different approaches to that. But some did identify policy uncertainty as one of the reasons for their writing down more uncertainty around inflation."
Powell added, though, that he believes the main reason officials are expecting higher inflation and fewer rate cuts next year is that progress on lowering price increases has stalled lately.
Broadly, Powell said, the Fed has made "a great deal of progress" in lowering an inflation measure from 5.6% to 2.8% since 2022. That, he said, supports Wednesday's rate cut. But recently, he added, "Inflation has been moving sideways." The journey toward the Fed's 2% inflation goal has "kind of fallen apart as we approach the end of the year." And that, he said, underlies a more cautious approach to rate cuts next year.
Beth Hammack, head of the Federal Reserve Bank of Cleveland, dissented to Wednesday's decision, preferring to keep rates unchanged.
What is the Fed interest rate now?
The Fed's move marks its third straight rate cut and brings its benchmark short-term rate to a range of 4.25% to 4.5%. The move is expected to reverberate through the financial system, lowering borrowing costs for credit cards, some mortgages and auto and other loans.
The rate cut will also nudge down bank savings rates that are finally generating healthy returns.
Will the Fed lower interest rates in 2025?
Fed officials now estimate they’ll lower the federal funds rate by just half a percentage point next year to a range of 3.75% to 4%, according to their median estimate, half the percentage point in drops they projected in September. And they predict another two cuts in 2026, bringing the rate to about 3.4%, a half point higher than previously forecast.
The Fed also raised its estimate of the normal, or “neutral,” rate that neither spurs nor slows the economy from 2.9% to 3%, suggesting officials may not need to trim the key rate as much to get to neutral.
The Fed reduces interest rates to make loans cheaper and bolster a sagging economy. It raises rates to wrestle down inflation by increasing borrowing costs and cooling the economy.
In 2022 and 2023, the central bank hiked the fed funds rate from near zero to a 23-year high of 5.25% to 5.5% in response to a pandemic-related spike in prices.
Despite cooling inflation, high prices remain top of mind for most Americans. Powell, during Wednesday's news conference, spoke about the Fed's role in bringing inflation down and the "tremendous pain" a previous burst of inflation brought.
"So, now we have inflation itself is way down, but people are still feeling high prices," he said. "That is really what people are feeling. The best we can do for them – and that's who we work for – is to get inflation back down to its target and keep it there so that people are earning big, real wage increases so that their wages are going up, their compensation is going up faster than inflation year upon year upon year.
"That's what will restore peoples' good feeling about the economy. That's what it will take, and that's what we're aiming for."
What is the inflation rate right now?
The Fed’s preferred overall inflation measure has tumbled to 2.3% – still above its 2% goal – from 7% in mid-2022, leading officials to cut the funds rate by an outsize half point in September and another quarter point early last month.
Recently, though, the Fed has been struggling to balance conflicting forces.
A core annual inflation reading that excludes volatile food and energy items – which the Fed watches more closely because its price changes are more durable – has edged higher, from 2.7% in July to 2.8% in October. And a different inflation gauge, the consumer price index, increased sharply for a fourth straight month in November.
The economy, meanwhile, grew at a healthy 2.8% annual rate in the third quarter and is projected to expand 3.1% in the current quarter, according to the Federal Reserve Bank of Atlanta’s forecast. A retail sales report this week underscored that consumer spending is still robust despite strains on lower-income households.
And job growth has bounced back from hurricanes and worker strikes that depressed payrolls in early fall, with 227,000 payroll gains in November.
At the same time, Fed officials have said the key rate is still too high in light of the sharp inflation drop-off and they want to bring it closer to neutral so it doesn’t unduly weaken the economy. Powell acknowledged "the labor market is still cooling by many measures" and officials don't want it to soften excessively.
In a note to clients, economist Samuel Tombs of Pantheon Macroeconomics said "rising unemployment will spur more" rate cuts next year than the Fed anticipates.
Also, despite the recent uptick in price increases, items that were driving inflation higher – such as rent, and car insurance and repairs – seem to have stabilized, providing hope that inflation will resume its descent.
As a result, the Fed appears to be taking a middle-ground approach: Cut the benchmark rate now to bring it closer to neutral sooner, but then move cautiously next year while assessing whether inflation is still falling, what the neutral rate really is, the health of the job market and any effects from Trump’s policies.
The U.S. Federal Reserve Building in Washington, D.C.
Tariffs are likely to be passed to consumers through higher prices. Deporting millions of migrants who lack permanent legal status could curtail labor force growth and push wages and inflation higher. And tax cuts could juice consumption and the economy, further stoking inflation.
What is the expected inflation rate in 2025?
Fed officials estimated Wednesday that their preferred measure of annual inflation, the personal consumption expenditures index, will rise from 2.3% to 2.4% by year-end, above the 2.3% they predicted in September, according to their median estimate. It’s projected to climb to 2.5% by the end of 2025, well above the prior 2.1% estimate.
The core PCE inflation reading is expected to hold at 2.8% this year, above the previous 2.6% estimate. It’s projected to fall to 2.5% by the end of next year, up from the prior 2.2% forecast.
Will the job market get better in 2025?
The 4.2% unemployment rate is projected to hold steady to end 2024, below the September forecast of 4.4%, the Fed’s median estimate shows. The rate is expected to close out 2025 at 4.3%, slightly below the prior 4.4% projection.
How will the economy be in 2025?
The Fed said it expects the economy to grow 2.5% this year, well above its prior 2% estimate. It also predicts 2.1% growth in 2025, compared with 2% previously.
Consumer spending, which makes up 70% of economic activity, has been resilient despite high interest rates and inflation. But low- and middle-income households are coping with record credit card debt and high delinquency rates.
