The US Federal Reserve has cut interest rates by 25 basis points (0.25%). Now the interest rates will be between 4.50% to 4.75%. Earlier on September 18, the Fed had cut interest rates by 50 basis points (0.5%).
The September cut was made after about 4 years. The Fed had cut interest rates after March 2020 in September 2024. To control inflation, the Central Bank of America had increased interest rates 11 times between March 2022 and July 2023.
Kept interest rates unchanged for the third consecutive time in 2023
Last year, the Federal Reserve had kept interest rates unchanged for the third consecutive time in its policy decision. On July 26, 2023, the Fed had kept the policy rate unchanged in the range of 5.25%-5.5% as per market expectations.
However, the Fed had also indicated that rate cuts will be seen in 2024 and it may come down to 4.6%. The Fed started raising rates from March 2022 to tackle inflation. By July last year, these rates had increased to the highest level in 23 years.
The Fed decides the rate how much interest banks will charge each other.
Federal rates decide how much interest banks will charge on loans given to each other overnight. But it often also affects consumer debt, mortgages, credit cards and auto loans.
What could be the impact of cut in interest rates?
- Stock market analysts believe that the cut in interest rates could lead to a rise in the stock market.
- Too many cuts could spoil America's economic health. Investors' enthusiasm may be dampened.
- Less cut leads to disappointment in the market, because the market is expecting more cut in interest rates.
- Delay in cutting interest rates may slow down 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 the policy rate. When inflation is very high, the Central Bank tries to reduce money flow in the economy by increasing the policy rate.
If the policy rate is high then the loan that banks get from the Central Bank will be expensive. In return, banks make loans costlier for their customers. This reduces money flow in the economy. If money flow decreases, demand decreases and inflation decreases.
Similarly, when the economy goes through a bad phase, there is a need to increase money flow for recovery. In such a situation, the Central Bank reduces the policy rate. Due to this, the loan received by the banks from the Central Bank becomes cheaper and the customers also get the loan at a cheaper rate.
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