Fed cuts interest rate by quarter-point

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.

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%.

Officials now foresee just two rate cuts in 2025, down from the four they envisioned in September. That would 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. And they predict another two cuts in 2026, bringing the rate to about 3.4%, a half-point higher than previously forecast.

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.

Beth Hammack, head of the Federal Reserve Bank of Cleveland, dissented to Wednesday's decision, preferring to keep rates unchanged.

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.

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.

At a news conference, Fed Chair Jerome Powell acknowledged that some policymakers are factoring Trump's promises into their estimates of inflation and rate cuts. He said, 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.

Broadly, he said, the Fed has made "a great deal of progress" in lowering a key inflation measure from 5.6% to 2.8% since 2022. That, he said supports Wednesday's rate cut.

But recently, he continued, "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.

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. But the Fed's preferred overall inflation measure has tumbled to 2.3% 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.

Fed officials estimated Wednesday that their favored 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. 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.

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. They want to bring it closer to neutral so it doesn't unduly weaken the economy.

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.

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.

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 to 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.

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 and any effects from Trump's policies.

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.

Wednesday's move is expected to reverberate through the financial system, lowering borrowing costs for credit cards, some mortgages and auto and other loans. But it will also continue nudging down bank savings rates that are finally generating healthy returns.