Fed cuts key interest rate by a quarter of a point, but continues to signal concern about inflation

The Federal Reserve announced Thursday that it cut its key interest rate by a quarter point — a widely expected move that coincides with inflation approaching the central bank’s target of 2 per cent.

In their statementFed officials noted that inflation remains “somewhat elevated” while unemployment has “moved up but remains low.” They noted that labor market conditions “have generally eased” — perhaps a nod to signs of growing softness in hiring.

Some market participants noted that officials removed key language that had previously indicated they were still confident it would hit the 2% inflation target.

In a note to clients, Omair Sharif, chairman of Inflation Insights, said it could signal a new willingness by the Fed to forego a widely expected further quarter-point cut next month.

“If that is the case, then the committee is probably closer to a break.

In other words, the central bank would keep interest rates elevated.

As the pain from four years of skyrocketing price growth lingers, there are now concerns that President-elect Donald Trump’s economic plan, particularly his tariff proposal, could trigger a new inflationary environment.

As of Wednesday, Wall Street traders were almost unanimously that the Fed would lower the federal funds rate, which serves as a benchmark for other borrowing rates in the economy, by a quarter of a point. The central bank is seeking to strike back on the restrictive lending environment it has put in place to stem rising inflation that took hold amid the pandemic.

With that reduction, the central bank’s federal funds rate falls to a range of 4.5% to 4.75%.

Heading into Tuesday’s presidential vote, the Fed would have been justified in celebrating the return of inflation back to its 2% target.

At the same time, unemployment remains subdued at 4.1%.

Essentially, the Fed has fulfilled its dual mandate of keeping inflation and unemployment low.

But the arrival at the finish line now coincides with Trump’s promise to introduce an entirely new financial and economic regime. While analysts remain unsure how exactly that could materialize and how severe it might be, markets have already reacted by selling off bonds in anticipation of a return to inflation from a combination of Trump’s pro-growth and anti-trade policies.

That would cause the Federal Reserve to halt its current trajectory of steadily cutting interest rates.

And that, in turn, would go directly against Trump’s goal of maintaining lower interest rates as part of a policy of accelerating economic growth.

“Although Trump has shown a consistent preference for easy monetary policy, we believe the Fed would engage in a less aggressive tapering cycle under another Trump administration due to the inflationary nature of additional tariffs,” analysts with Nomura Holdings’ financial group wrote in a note to customers in the autumn.

Trump and the GOP have denied the tariffs would be inflationary, pointing to Trump’s success in imposing tariffs in his first term without reigniting inflation.

“During his first term, President Trump imposed tariffs on China that created jobs, spurred investment and resulted in no inflation,” Anna Kelly, a spokeswoman for the Republican National Committee, said.

Still, those tariffs, of $300 billion on selected Chinese goods, were much more targeted than the $3 trillion in general tariffs that Trump is now expected to propose. And the inflationary environment is also different now: During Trump’s first term, inflation only briefly rose above 2%.

David Seif, chief developed markets economist at Nomura, said Fed Chairman Jerome Powell is likely to deflect any direct questions he gets Thursday about how he perceives his role and responsibilities to change once Trump takes office.

It was Trump who appointed Powell to lead the Federal Reserve in his first term. But Trump has signaled a willingness this year to abandon the longstanding principle of maintaining the Fed as an independent body.

“I think I have the right to say, I think you have to go up or down a little bit,” Trump said in a Bloomberg News interview at the Chicago Economic Club last month, according to Reuters. “I don’t think I should be allowed to order it, but I think I have the right to make comments on whether interest rates should go up or down.”

Seif said that if Trump releases the full extent of the tariff plan he has proposed, it would create “an acute inflationary event.” While that wouldn’t necessarily be permanent, Seif said, it would require the Fed to stop its monetary easing.

In general, growth is much more stable now. Trump’s policies, Seif said, could end up adding fuel to the fire — forcing the Fed to act in a way that Trump would not see favorably.