If Inflation Improves, Are Interest Rate Cuts Back on the Table?

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Following three months of hotter-than-expected inflation reports, no one imagined the Federal Reserve would start cutting rates at its policy meeting earlier this month. The Fed is holding the federal funds rate high, at a target range of 5.25% to 5.50%, until the economy shows more definitive signs of slowing. 

But what happens if this week’s inflation report moves down closer to the Fed’s 2% annual inflation target? Could we see an interest rate cut before the end of 2024?

I’m shocked that I’m still hearing people calling for rate cuts and anticipating rate cuts. I don’t know how they think that’s possible at this point.

Don’t bet on it, according to one economist.

“I’m shocked that I’m still hearing people calling for rate cuts and anticipating rate cuts,” said Gregory Heym, chief economist at real estate service company Brown Harris Stevens. “I don’t know how they think that’s possible at this point.”

However, not everyone is convinced that rate cuts are completely out of the question. There’s still a slim possibility for inflation to downshift in time for a late summer rate cut, according to a report from Wells Fargo senior economist Sarah House.

The report predicts inflation will trend lower over the remainder of the year and that core inflation — which excludes food and energy costs — could drop to 2.8% annually toward the end of the year.

Why does CPI matter?

The Consumer Price Index is the most widely used measure of inflation, reflecting changes in how much we pay for goods and services over time. 

Elevated inflation reduces our purchasing power, and the government tries to keep inflation in check by hiking interest rates. By increasing the cost of borrowing money with higher rates, the Fed can slow down consumer and business spending, eventually leading to a drop in prices. Then, when inflation cools, the Fed starts lowering interest rates, making credit less expensive and encouraging consumer spending.

After the Fed raised interest rates 11 times between March 2022 and July 2023, inflation dropped from its high of 9.1% in June 2022 to 3% one year later. But inflation has inched back upward in the first part of 2024, increasing in March to 3.5% annually.

How the Fed’s decision affects your money

With five meetings left for this year, the Fed could still begin lowering rates, so long as inflationary pressures continue to ease. A single cut would most likely leave the target range at 5% to 5.25%. Assuming the central bank cuts rates slowly and gradually, we likely won’t feel the effects until at least 2025. 

The Federal Open Market Committee has five meetings scheduled through the end of 2024: June 11-12, July 30-31, Sept. 17-18, Nov. 6-7 and Dec. 17-18.

When interest rates are high, that’s generally bad news for borrowers but good news for savers. Here’s what adjustments to interest rates mean for you and your money.

Mortgages and refinancing

Mortgage and refinance rates are volatile and still relatively high. Rates are expected to decline slowly this year and into next, but don’t expect them to drop back to pandemic lows. If you’re ready to buy a home, focus on finding a house that’s within your budget and use these expert tips to score a lower rate.

Credit cards

Interest rates on credit cards will likely remain high throughout this year. The average credit card interest rate is 20.66% as of May 8, according to CNET sister site Bankrate. If you’re carrying debt on your credit cards, prioritize paying off the balance quickly to avoid accruing interest charges. Consider a balance transfer or debt consolidation loan to reduce the amount you’re paying in interest while chipping away at your balance.

Savings and CDs

You can still earn high interest rates on your savings, with some high-yield savings accounts and CDs offering annual percentage yields of around 5% or higher. That’s slightly down from their 2023 highs, but expect them to drop if the Fed signals that a rate cut is on the way.

What else could affect the Fed’s decision to lower interest rates?

Although the CPI report gets a lot of attention, it’s not the only way to measure inflation. The Personal Consumption Expenditures price index includes more comprehensive data than the CPI. The Fed looks at PCE numbers for a more accurate picture of price stability. PCE inflation tends to run slightly lower than the CPI’s: For March, the PCE price index increased 2.7% year over year. 

Other factors, like unemployment and the state of the labor market, also affect the Fed’s monetary decisions. Unemployment was 3.9% in April, up slightly from 3.8% in March, according to this month’s Bureau of Labor Statistics report. Though the change is small, a softening labor market could eventually prompt the Fed to lower interest rates to encourage companies to start investing and hiring. 

“Over the past year, as labor market tightness has eased and inflation has declined, the risks to achieving our employment and inflation goals have moved toward better balance,” Fed Chairman Jerome Powell said at the press conference following the May 1 Fed meeting.

Yet if the government shifts policy too quickly or too much, it could reverse this progress. “The economic outlook is uncertain, however, and we remain highly attentive to inflation risks,” said Powell.