Enlarge image

US Federal Reserve Chairman Jerome Powell: "We will not declare victory at this point."

Photo: Julia Nikhinson / AFP

The US Federal Reserve (Fed) is leaving its key interest rate unchanged at a high level for the fourth time in a row. It remains in the range of 5.25 to 5.5 percent, as the Central Bank Council announced. Commercial banks can borrow central bank money at this rate. The decision was expected. It is the highest value in more than two decades.

Interest rate cuts possibly “sometime this year”

The Fed made it clear that it was not yet ready to cut interest rates. One must first gain more confidence that inflation is moving sustainably towards 2 percent, said the statement from the US Federal Reserve. Fed Chairman Jerome Powell said the Fed is prepared to maintain high interest rates for longer. “Inflation is still too high and further progress in reducing it is not assured,” warned Powell. However, he made it clear that the current interest rate level has “probably reached its peak.” Powell promised possible interest rate cuts “sometime this year.” The decision as to when these could come depends, among other things, on how persistent inflation is. "We will not declare victory at this point."

Fight against inflation

Since March 2022, the Fed has raised its key interest rate by more than five percentage points at a record-breaking pace in the fight against inflation - but has recently stopped adjusting the interest rate screw. The rapid inflation was triggered, among other things, by the rise in energy prices after the Russian attack on Ukraine. With inflation easing, it was expected that the US Federal Reserve could cut interest rates soon. In December the annual rate was 3.4 percent. The US Federal Reserve is aiming for price stability of 2 percent in the medium term.

Keeping inflation under control is the classic task of central banks. They are turning the interest rate screw in the fight against high consumer prices. If interest rates rise, private individuals and businesses have to spend more on loans - or borrow less money. Growth is slowing, companies cannot pass on higher prices indefinitely - and ideally the inflation rate is falling. At the same time, however, there is a risk of a recession. Finding the right balance is the big challenge for central bankers.

The Fed's rapid interest rate hikes had dampened growth in the largest economy. Last fall, however, the US economy grew more strongly than expected. In the fourth quarter, the gross domestic product increased by 3.3 percent on an annual basis compared to the previous quarter, as the US government announced about a week ago. Experts had expected an average of 2 percent. Economists were positively surprised. The prospects of avoiding a recession have improved. Given the robust economic growth, the Fed is unlikely to be in any hurry to cut interest rates.

Observers do not expect a rate cut until after the next meeting in March at the earliest. So far it appears that the Fed has managed to slow down price increases without completely slowing down the economy. In December, Fed decision-makers expected an average key interest rate of 4.6 percent for this year. This suggests around three interest rate cuts in 2024 – experts assume more. But good economic data is reducing the pressure on the Fed to significantly reduce interest rates quickly.

Be careful when lowering too quickly

Despite the greater scope due to falling inflation, Fed Chairman Powell repeatedly urges caution. He has already emphasized in the past that the data should be viewed with caution and that we have to wait and see whether the decline is permanent. He fears that if interest rates are cut too quickly, inflation could skyrocket again. Because greater purchasing power could trigger a surge in inflation. This would likely result in rapidly rising consumer prices.

Unlike in the euro area, inflation in the USA is primarily driven by high demand and a strong labor market. A strong labor market generally makes it harder for the Fed to fight inflation because it drives up wages.