The US Federal Reserve has cut interest rates by 50 basis points. Now the interest rate will be between 4.75% to 5%. Earlier in March 2020, the Fed cut interest rates. To keep inflation under control, the US central bank hiked interest rates 11 times between March 2022 and July 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.
What can be the effect of reduction in interest rate?
- Stock market analysts believe that a major cut in interest rates can lead to a bullish stock market.
- Excessive cuts could also raise concerns about America's economic health, dampening investor sentiment.
- A small cut (around 25bps) could cause market disappointment, as the market expects a big cut in interest rates.
- A delay in interest rate cuts could slow the job market. So the central bank will need to act cautiously.
- According to reports, Fed officials have indicated that labor market data will now play a more important role in their decisions than inflation.
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 raising policy rates.
If the policy rate remains high, the loans that banks get from the central bank will become expensive. In turn, banks 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. Due to 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).
