US Fed cuts interest rates for the first time in four years

Central bank cuts interest rates by 50 basis points in effort to protect world's largest economy

Federal Reserve chairman Jerome Powell. AFP

The Federal Reserve cut US interest rates by 50 basis points on Wednesday, marking the start of its first easing cycle in four years to protect the labour market now that inflation is easing.

After Wednesday's decision, the Federal Open Market Committee (FOMC) reduced its benchmark lending rate from 5.25-5.50 per cent to 4.75-5.00 per cent.

A 50-basis point cut is seen as a more urgent manoeuvre – as opposed to a more traditional 25 basis points – because it could suggest the Fed is concerned about economic growth. A smaller rate could indicate the Fed believes the economy is still strong.

“Over the past two years, the labour market has cooled from its formerly overheated state. Inflation is eased substantially,” Fed chairman Jerome Powell told reporters.

Mr Powell said the Fed has “gained greater confidence” that inflation is on a downwards trend towards 2 per cent, while the downside risk to employment has increased.

“This recalibration of our policies will help maintain the strength of the labour market,” he said, adding it would also help further progress on inflation as the Fed begins to move towards a more neutral stance.

"This decision reflects our growing confidence that with an appropriate recalibration of our policy stance, strength in the labour market can be maintained in a context of moderate growth and inflation moving sustainably down to 2 per cent."

Futures markets had estimated about a two-thirds probability that the Fed would begin with an aggressive 50-basis point reduction.

“Traditionally, the FOMC doesn't want to surprise the market, especially with the first move in the cycle,” Laurence Meyer, former Fed governor and co-founder of the advisory company LHMeyer, wrote to clients on Monday.

Officials projected the federal funds rate to end the year at 4.4 per cent. The unemployment rate is forecast to rise to 4.4 per cent, while a rosier outlook on inflation is seen at 2.3 per cent (compared to 2.6 per cent from June).

Mr Powell dismissed suggestions that the Fed's decision to deliver the larger rate cut was an indication that it had fallen behind the curve.

"We think this is timely but I think you can take this as a sign of our commitment not to get behind. So it's a strong move," he said.

Lowering interest rates typically indicates lower borrowing costs for consumers and businesses, fuelling economic growth and consumer sentiment. It also weakens the dollar against non-dollar-pegged currencies, and lifts asset prices.

“On the other hand, lowering rates quickly presents a number of risks, in particular with regards to the credit cycle and inflation,” wrote Yves Bonzon, group chief investment officer at Julius Baer.

Turning point

The announcement marks a significant turning point for the Fed, which raised interest rates from near-zero in 2022 to its current level of about 5.33 per cent, where it has remained for almost 14 months.

The rate increases came amid a global increase in inflation caused by supply-chain bottlenecks and a mass return of workers to the labour force.

Many central banks in the Gulf followed the Fed's lead in increasing rates from 2022 to 2023, and by holding them steady since last July, because of the peg to the dollar. They are expected to mirror the Fed's actions again by reducing their own rates.

Wednesday's decision indicates that the Fed believes it has beaten inflation. Its preferred metric, which had peaked at 7.1 per cent two years ago, is now at 2.5 per cent and seen as moving sustainably towards its long-term 2 per cent target.

It also gives increasing belief that the Fed is moving closer to achieving a "soft landing", where inflation is brought back under control without a large increase in unemployment or a recession. Fed officials are now focusing on the other half of their dual mandate, which is maximum employment.

Recent economic data shows that the labour market is cooling, yet still healthy. The Labour Department's employment report for August came in softer than expected, with employers adding 142,000 jobs, fewer than economists had predicted. That followed a downwardly revised 89,000 jobs added in August.

Meanwhile, the unemployment rate has climbed from 3.4 per cent in January to its current level of 4.2 per cent.

Although Mr Powell and his colleagues said this data supports a moderating economy as expected, they do not want to see any further weakening.

He went even further in his Jackson Hole address in July, when he made it clear that he intends to protect the labour market, saying any further cooling would not be tolerated.

On average, non-farm payrolls increased by 116,000 over the past three months, which is the slowest pace since the start of the pandemic.

Mr Powell said the average gain is something that "bears close watching".

Still, Fed officials in recent weeks did not seem rattled by slowing growth. The US economy has thus far defied recession predictions, in large part due to strong consumer spending and a wave of immigration supporting the labour force.

The US gross domestic product grew by 2.5 per cent last year, compared to 1.9 per cent in 2022. The GDP grew by a rate of 3 per cent in the second quarter this year, according to the Bureau of Economic Analysis.