The Federal Reserve cut interest rates by 50 basis points Wednesday, the central bank’s first rate reduction following a two-and-a-half-year crusade against inflation that raged in the wake of the pandemic.
The new federal funds rate is 4.75 percent to 5 percent, a jumbo cut that signals the Fed’s confidence that its war against inflation is coming to an end.
The pandemic hit the economy hard, scrambling supply chains, shuttering stores and leading to layoffs of millions of Americans. When the world started to reopen in the spring of 2021, however, the economy went into overdrive.
The consumer price index (CPI), an inflation measure that tracks a handful of goods and services, soared above ideal levels. Although Biden administration officials initially waived off the increase as “transitory,” prices kept rising, and November 2021, inflation hit the highest rate since 1982.
The Fed incrementally increased interest rates from near zero in March 2022 to a range of 5.25 to 5.5 percent last July as it battled rising inflation, which peaked at 9.1 percent in June 2022.
While rate hikes fueled recession concerns and layoff fears, a recession never came to pass, and the unemployment rate maintained its lowest sub-4 percent streak since the 1960s.
The jobless rate ticked up to 4.3 percent in July and clocked at 4.2 percent last month. That’s relatively low by historical standards but still a sign of labor market “cooling” the Fed had been watching for as it waited to cut rates.
The CPI also fell below 3 percent in July for the first time since March 2021 and fell further to 2.5 percent in August, within striking distance of the Fed’s 2 percent target.
The uptick in unemployment and consumer-friendly CPI reading sparked concerns and renewed criticisms that the Fed may be behind on interest rate cuts, with Sens. Elizabeth Warren (D-Mass.), Sheldon Whitehouse (D-R.I.) and John Hickenlooper (D-Colo.) arguing in a Monday letter to Powell that the central bank’s “delays have threatened the economy and left the Fed behind the curve.”
While some economists believe the Fed could have started cutting rates in July, the next few months are critical as the central bank attempts to bring the economy in for a “soft landing,” maintaining its dual mandate of low inflation and maximum employment as it brings down rates.
How far and how fast the Fed cuts rates moving forward remains to be seen. While Fed Chair Jerome Powell told lawmakers earlier this year that the era of near-zero interest rates is likely over, the central bank projected in June that the median interest rate to drop to 4.1 percent in 2025 and 3.1 percent in 2026.
The Fed further lowered its median rate forecast Wednesday to 3.4 percent next year and 2.9 percent in 2026, and in the long run, according to new economic projections.
“This would only be the first cut of a rate-cutting cycle. The size and frequency of future cuts will give us a better understanding of whether the Fed believes they are behind, or ahead of, ‘the curve,’” said Jonathan Ernest, an economics professor at Case Western Reserve University.
Updated at 2:15 p.m. EDT