Federal Reserve cuts rates by half a point and signals era of easing has begun

The Federal Reserve has cut its benchmark interest rate by half a percentage point and signalled more reductions would follow, launching its first easing cycle since the onset of the pandemic.

The US central bank’s first cut in more than four years leaves the federal funds rate at a range of 4.75% to 5%. Michelle Bowman, a governor on the Federal Open Market Committee, voted against the decision, favouring a quarter-point reduction.

The half-point cut is larger than the Fed’s more customary quarter-point pace and suggests the US central bank is concerned about the prospects of a weakening economy after more than a year of holding rates at a 23-year high.

The last time the Fed cut rates by more than a quarter point was when Covid-19 tore across the global economy in 2020.

In a policy statement on Wednesday, the FOMC said it had gained “greater confidence” about inflation, even though it remained “somewhat elevated”.

Amid slowing job gains and a higher unemployment rate, officials noted the risks to achieving their price stability goal while also maintaining a healthy labour market were “roughly in balance”.

US stocks rallied immediately after the announcement. The S&P 500, which was steady earlier in the day, jumped as much as 0.9%, surpassing the intraday record high it briefly hit on Tuesday. Treasury yields fluctuated between gains and losses after a mild sell-off before the announcement.

In the latest “dot plot” of officials’ forecasts, most expected the policy rate would fall to 4.25% to 4.5% by the end of 2024, suggesting another large half-point reduction at either of the two remaining meetings this year or two quarter-point reductions. Overall, that is a significantly larger reduction than the quarter-point reduction projected by most officials in June, when the dot plot was last updated.

Two of the 19 officials who pencilled in estimates thought the Fed should hold off after Wednesday’s reduction, while another seven forecast only one more quarter-point cut this year.

Policymakers also expected the funds rate to fall another percentage point in 2025, ending the year between 3.25-3.5%. By the end of 2026, it was estimated to fall just below 3%.

In considering additional cuts, the FOMC said it would “carefully assess incoming data, the evolving outlook, and the balance of risks”.

Wednesday’s decision is a milestone for the central bank after more than two years battling inflation – and a significant moment in this year’s presidential election.

Falling borrowing costs will be a boon for Democratic candidate Kamala Harris, whose campaign has been dogged by voter disquiet over high living costs even as the US economy has boomed.

The cut comes as Fed officials grow more confident that inflation is under control and turn their focus to the health of the labour market.

After peaking in 2022 at about 7%, the personal consumption expenditures price index was just 2.5% in July, closer to the Fed’s 2 per cent target.

But jobs growth has cooled in recent months and other measures of demand, such as vacancies, have also slowed, even though the number of Americans filing for unemployment benefits remains historically low.

While the Fed has made clear it does not want to see further labour market weakening it is also concerned about moving too slowly in loosening its grip on the economy by lowering borrowing costs.

In projections released on Wednesday, most officials forecast the unemployment rate to peak at 4.4% over the next two years, up from its current level of 4.2% and higher than June’s estimates, while economic growth stabilises at a 2% rate over the next several years.

Officials also forecast a more benign inflation backdrop, with the personal consumption expenditures price index falling back to target in 2026. The median estimate for “core” inflation, which strips out volatile food and energy prices, was revised lower to 2.6% for this year, before falling to 2.2% and 2% over the next two years.

© The Financial Times