The US Federal Reserve has cut interest rates by 25 basis points (0.25%). Now the interest rate will be between 4.50% to 4.75%. Earlier on September 18, the Fed cut interest rates by 50 basis points (0.5%).
The September cut was made after about 4 years. The Fed has cut interest rates since March 2020 in September 2024. The US central bank hiked interest rates 11 times between March 2022 and July 2023 to keep inflation under control.
Interest rates kept unchanged for the third consecutive time in 2023
Last year, the Federal Reserve kept interest rates unchanged for the third time in a row in its policy decision. On July 26, 2023, the Fed kept the policy rate unchanged in the range of 5.25%-5.5%, in line with market expectations.
However, the Fed also hinted that 2024 would see a rate cut and it could fall to 4.6%. The Fed started raising rates from March 2022 to meet inflation. By July last year, these rates had risen to a 23-year high.
The Fed rate determines how much interest banks will charge each other
The federal rate determines how much interest banks will charge each other on overnight loans, but it also often affects consumer debt, mortgages, credit cards and auto loans.
What can be the effect of reduction in interest rate?
- Stock market analysts believe that the reduction in interest rates can lead to a boom in the stock market.
- Too many cuts could undermine America's economic health. Investors may lose enthusiasm.
- A lower cut leads to pessimism in the market, as the market expects further cuts in interest rates.
- A delay in interest rate cuts could slow the pace of the job market.
Policy rate is a powerful tool to fight inflation
Any central bank has a powerful tool to fight inflation in the form of policy rate. When inflation is too high, the central bank tries to reduce the flow of money into the economy by increasing the policy rate.
If the policy rate remains high, the loans that banks get from the central bank will become expensive. Banks in turn make loans more expensive for their customers. This reduces the flow of money in the economy. If the flow of money decreases, demand decreases and inflation decreases.
Similarly, when the economy goes through a bad phase, the recovery needs to increase the flow of money. In such a situation, the central bank reduces the policy rate. Because of this, the loans from the central bank become cheaper for the banks and the customers also get loans at cheaper rates.
Image Credit: (Divya-Bhaskar): Images/graphics belong to (Divya-Bhaskar).
