The US Federal Reserve cut its key interest rate by a quarter of a point on Wednesday – its third cut this year – but also signaled it expects to cut interest rates next year more slowly than previously thought, with inflation still well above two levels. percentage of the central bank target.
The Fed's 19 policymakers projected it would cut its benchmark rate by a quarter of a point just twice in 2025, down from September's estimate of four rate cuts. Their new forecasts suggest that consumers may not enjoy significantly lower rates on mortgages, auto loans, credit cards and other forms of borrowing next year.
Fed officials have emphasized that they are slowing interest rate cuts as their benchmark rate approaches a level that policymakers call “neutral” – a level that is believed to neither stimulate nor hinder the economy.
Wednesday's forecasts suggest policymakers may not think they are too far from that level. Their benchmark rate is 4.3 percent after Wednesday's change, which follows a sharp half-point cut in September and a quarter-point cut last month.
“I think the slower pace of rate cuts really reflects both the higher inflation readings we've seen this year and the expectation that inflation will be higher” in 2025, Chairman Jerome Powell said at a news conference.
“We are closer to the neutral rate, which is another reason to be cautious in further moves.
“Despite this,” Powell said, “we believe we are still on track for cuts.”
The loonie glides in response to the cut
The Canadian loonie fell against the U.S. dollar – which continues to outperform other currencies – in response to Wednesday afternoon's cut.
“Jerome Powell talked about the U.S. economy clearly outperforming expectations not only domestically but also across the rest of the world,” said Karl Schamotta, chief market strategist at Corpay, a payments management company in Toronto.
“This means that interest rates in the US are high, which makes US markets the best place in the world to park your money.”
Several other factors have contributed to the lunatic's decline over the past few months and years, including the end of the “supercycle” that created high demand for Canadian energy, as well as high household debt slowing consumer spending and Trump's threat to impose a 25 per cent tariff for Canadian goods.
That way, “you basically have a killer cocktail for the Canadian dollar,” Schamotta told CBC News. And the lunatic could go “at least a few cents lower” if Trump makes good on his threat.
This would hit the export sector hard. Schamotta said Canadian consumer sentiment will deteriorate and businesses will continue to disinvest.
“All this would mean that Canada will most likely fall into a recession.”
But Canadian exporters feel the pain when the lunatic overperforms against the U.S. dollar, Schamotta said. A lower adjustment could mean that some of these exports “will be in a better position.”
“They will be able to sell cheaper exports to the world and they will be able to develop,” he said. “So it is a process of rebalancing.”
Inflation remains high and the pace of hiring is slowing
This year's Fed rate cuts marked a turnaround after more than two years of high rates, which largely helped tamp down inflation but also made borrowing painfully expensive for American consumers.
However, the Fed currently faces a number of challenges as it seeks to complete a soft landing of the economy in which high interest rates can curb inflation without triggering a recession. Chief among them is that inflation remains stubborn: According to the Fed's preferred measure, annual “core” inflation, which excludes the most volatile categories, was 2.8% in October. This remains above the central bank's two percent target.
At the same time, the economy is growing dynamically, which suggests that higher interest rates have not slowed it down much. As a result, some economists – and some Fed officials – have argued that lending rates should not be cut further for fear of the economy overheating and inflation rising again.
On the other hand, the pace of hiring has slowed significantly since the beginning of 2024, which may be a concern since one of the Fed's mandates is to achieve maximum employment.
“We don't believe we need further cooling in the labor market to bring inflation below two percent,” Powell said at a news conference.
The unemployment rate, while still low at 4.2 percent, has increased by almost a full percentage point over the past two years. Concerns about rising unemployment contributed to the Fed's decision in September to cut its key interest rate by more than the usual half-point.
Trump's tariff threats increase uncertainty
Moreover, US President-elect Donald Trump has proposed a series of tax cuts and regulatory easing that together could boost economic growth. And his threats of tariffs and mass deportations could accelerate inflation.
Powell and other Fed officials said they could not assess how Trump's policies might affect the economy, or their own interest rate decisions, until more details were made available. Until then, the presidential election result was the biggest contributor to economic uncertainty.
This was highlighted in the quarterly economic projections released by the Fed on Wednesday.
Policymakers now expect overall inflation, as measured by their preferred measure, to rise slightly from 2.3 percent today to 2.5 percent by the end of 2025.
Officials also expect the unemployment rate to rise slightly by the end of next year, from the current 4.2 percent. to a still low level of 4.3 percent.