The question is not whether interest rates will be cut, but by how much
THERE HAS been a “sea change” in American monetary policy this year, according to James Bullard, president of the Federal Reserve Bank of St Louis. He is right. In January the central bank was expected to continue raising interest rates. By March it had adopted a steady-as-she-goes approach, signalling to markets that it would be “patient”. In June, as worries about global growth and trade grew, it pivoted toward a looser stance.
Today, as the Fed begins its two-day Federal Open Market Committee meeting, the question is not whether it will cut, but by how much. Prices in the federal-funds futures market suggest that investors think there is about an 80% chance of a quarter-point rate cut this week; the chance of a half-point cut is 20% . By the end of the year, most traders reckon the benchmark interest rate, currently set at 2.25%-2.50%, will be lowered by either half a point or three-quarters of a point .
Yet policymakers are right to worry about several risks. The first is a global economic slowdown. Last week the IMF cut its forecast for global growth in 2019 and 2020; China’s economy is growing at its slowest pace in almost three decades. Uncertainty over President Donald Trump’s trade wars, meanwhile, has hurt business confidence and helped domestic investment to stall. Finally, the Fed’s preferred measure of consumer-price inflation, currently at 1.6%, is below the bank’s 2% target.
A rate cut this week is seen by many as an insurance policy against a future downturn. By acting now, when the economy is still relatively healthy, the Fed can avoid taking more drastic action later on. This is what it did in 1995 and 1998, averting a recession on both occasions. Richard Clarida, the bank’s vice-chairman, has been a strong proponent of this approach.
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