Federal Reserve Likely to Slow Interest Rate Cuts in 2025, Signaling Economic Shift

The U.S. Federal Reserve is expected to reduce its key interest rate by a quarter point on December 18, 2024, bringing it down from approximately 4.6 per cent to 4.3 per cent.

This move, part of a broader pattern of rate cuts, comes after a half-point reduction in September and another quarter-point cut in November. However, this latest decision suggests that the pace of cuts may slow down in the coming year.

Central bank officials are likely to shift their approach, moving away from regular rate cuts and potentially limiting reductions to just two or three over the course of 2025.

This marks a shift in policy after a series of rate reductions aimed at countering high inflation. The U.S. inflation rate peaked at 7.2 per cent in mid-2022 but has since dropped significantly to 2.3 cent in October 2024, according to the Fed’s preferred gauge. With inflation much lower, many Federal Reserve members believe the aggressive rate hikes from the past year may no longer be necessary.

Despite this, inflation remains above the Federal Reserve’s 2 per cent target, and the economy continues to grow. Recent data from the government’s retail sales report, released on December Tuesday, highlights strong consumer spending, particularly among higher-income groups. This has led some analysts to warn that continued rate cuts could lead to excessive economic growth, potentially fueling inflation once again.

In addition, incoming President Donald Trump has proposed a series of tax cuts, including those for Social Security benefits and income from overtime and tips, alongside reducing regulations.

These proposals could stimulate economic activity. However, Trump has also suggested introducing tariffs and pursuing mass deportations, policies that could exacerbate inflationary pressures.

The uncertainty surrounding Trump’s economic agenda and the potential impact on the Federal Reserve’s decisions remains high. Fed officials, including Chairman Jerome Powell, have stated that they will need more details about Trump’s policies before determining how they might affect the economy and future rate decisions.

As a result, while borrowing costs have decreased from last year’s highs, they are unlikely to return to pre-pandemic levels anytime soon. The average rate for a 30-year mortgage was 6.6 per cent last week, down from a peak of 7.8 per cent in October 2023. However, the historically low mortgage rates of around 3 per cent seen before the pandemic are not expected to return in the near future.

Fed officials have emphasized that as the central bank approaches its “neutral” rate, which neither stimulates nor restricts economic growth, they are being more cautious with rate cuts.

Powell recently noted that the economy is growing stronger than expected, and inflation is slightly higher, allowing the Fed to be more measured in its approach as it seeks to find a balanced stance.

Meanwhile, global central banks are also adjusting their monetary policies. The European Central Bank, for example, recently cut its key interest rate to 3 per cent from 3.25 per cent, marking its fourth reduction of the year. This follows a decrease in inflation across the eurozone, which fell to 2.3 per cent in late 2024 from a high of 10.6 per cent in late 2022.

As the Federal Reserve continues to assess the state of the U.S. economy, Americans may face a prolonged period of relatively high borrowing costs despite efforts to reduce interest rates. The next steps for the Fed will likely depend on both domestic economic conditions and broader global trends.