What are interest rates and why do they matter to most Americans?
The Federal Reserve has refused to cut interest rates for another month. What are interest rates and why do they matter to Americans?
An interest rate cut is unlikely at this week’s Federal Reserve meeting, but most economists are predicting one in September.
The central bank’s benchmark short-term rate is 5.25% to 5.5%, a 23-year high from July 2023, as the central bank waits for inflation to cool further. Annual inflation eased to 3.0% from 3.3% in June – well below the two-decade high of 9.1% in June 2022, but still above the central bank’s 2% target. Excluding volatile food and energy prices, the key rate fell to 3.3%, the lowest since April 2021.
Most economists only expect the central bank to consider a rate cut soon, when its two-day policy meeting ends on Wednesday. They believe inflation is heading in the right direction, and two months of cooler inflation reports will help the central bank cut rates.
But “the signal will be subtle,” wrote Ryan Sweet, chief U.S. economist at research firm Oxford Economics, in a note. “Those looking for a clear signal will be disappointed.”
Interest rates are the main tool used by the central bank to reduce inflation. Higher rates make borrowing more expensive, which slows spending and the economy, generally easing inflation.
Why can’t the central bank give a clear timeline for rate cuts?
Capping inflation is “necessary – but not sufficient on its own – for a September interest rate cut,” said James Knightley, chief international economist at Dutch bank ING.
The central bank should look for more evidence of softening in the labor market and consumer spending, he said.
“We have seen many times in this cycle that the pace of inflation is not linear,” said Peixen Lin, investment strategist at Russell Investments. “With the labor market and economic activity in the U.S. still relatively strong, I think Powell is likely to offer only muted hints about policy action in September.”
The unemployment rate rose to 4.1% in June, the highest since November 2021, from 4.0% in May, mostly because more people were looking for work, not losing jobs, Knightley said.
Meanwhile, consumer spending remains resilient, rising a solid 2.3% annually from April to June, well ahead of the 1.5% pace earlier this year, but less than 3% in the second half of 2023.
Should the central bank be more flexible?: Should the central bank relax its 2% inflation target and cut interest rates? Yes, say some experts.
What will the central bank say?
The central bank “may express ‘overconfidence’ that inflation is moving steadily toward 2%,” Gregory Dago, chief economist at Parthenon EY, wrote in a note, but inflation won’t be the only thing on the central bank’s mind this time around.
“Notably, Powell began to emphasize the downside risks to the economy and the labor market if the Fed waits too long or is too cautious in cutting interest rates,” Sweet said.
While the latest economic data shows a rebound, “consumer fundamentals may not be as solid as they once appeared,” Michael Ferroli, JP Morgan’s chief U.S. economist, said in a statement.
With soft inflation-adjusted income growth, the Savings rate falls to 18-month low 3.4% in June and low-income households were stretched, Ferroli said. Already depressed confidence measures are also falling, and jobless claims are high.
Along with easing inflation, the central bank’s two goals — maximum employment and stable prices — are coming back into balance, which economists expect the central bank to agree to. However, the central bank says it needs to see more data to be sure.
Sweet expects the central bank to say that “although the unemployment rate has risen, it remains historically low” and that inflation has eased “but remains above the group’s 2% target.”
When can the central bank give a clear rate cut signal?
Powell will have another chance to talk about interest rates on August 22-24 Meeting at Jackson Hole, Wyoming Officials and economists around the world are debating the policy.
He said the Fed could adjust its language this week, “to reflect the possibility of tapering at the next meeting, (but) we doubt Chairman Jerome Powell will be more forthright about the move until the Jackson Hole Symposium in August.” Stephen Brown, Capital Economics’ Deputy Chief North America Economist, in a note.
Medora Lee is a money, markets and personal finance reporter at USA TODAY. You can reach her at [email protected] and Subscribe to our free daily money newsletter Every Monday through Friday morning for personal financial tips and business news.
