Resurgence of inflation in 2025 likely to limit Fed’s ability to continue rate cutting cycle: Expert

By Ovunc Kutlu

ISTANBUL (AA) - A resurgence of inflation in the US next year will likely limit the Federal Reserve’s ability to continue its interest rate cutting cycle, according to an expert.

The Fed on Wednesday lowered its interest rate by 50 basis points to a range of 4.75%-5.0%, starting its monetary easing in an aggressive way. The move marked the first rate cut by the central bank in more than four years, since the beginning of the coronavirus pandemic.

Except for the emergency rate cuts during the start of the pandemic, the last time the Fed delivered a 50 basis point rate cut was during the global financial crisis in 2008.

"While an initial cut of 50 bps is uncommon, it is not unprecedented in Fed history," Lauren Saidel-Baker, an economist at US-based research and consulting firm ITR Economics, told Anadolu in an email. "With the much-debated 25bp vs 50bp question now settled, attention can turn to the far more important question of the overall magnitude of cuts this cycle."

"Yet the inflation concern of the dual mandate is far from absent, with disinflation persisting but rates remaining elevated compared to recent history," she added.

Saidel-Baker said the Fed’s preferred measure of inflation, the core personal consumption expenditures (PCE) price index, still remains above the 2% target.

The core PCE price index annually increased 2.6% in July, unchanged from June, while it monthly rose 0.2% in July, following a 0.2% month-on-month increase in June.

The PCE price index, which includes food and energy prices, annually rose 2.5% in July, after increasing 2.5% in June year-on-year. That index, on a monthly basis, increased 0.2% in July, following a 0.1% gain in June.

- 'Cracks beginning to form in labor market'

Saidel-Baker said recent data continue to show that there is softening in the macroeconomy, adding that cracks are especially beginning to form in the labor market.

"While the underlying fundamentals are far from weak, the directional pullback will encourage the pace of interest rate cuts going forward," she said.

"Indeed, both the FOMC statement and Chair (Jerome) Powell's press conference turned far more attention toward the labor market side of the Fed’s dual mandate," she added.

Powell told the post-meeting press conference that the US labor market is in "solid condition" and the American economy is in "good shape," while it is growing at "a solid pace."

He added that the Fed's current objective is to keep the inflation level stable and making sure that jobless rates do not increase further during that time.

"We’re trying to achieve a situation where we restore price stability without the kind of painful increase in unemployment that has come sometimes with disinflation," he said.

- 'Higher for longer'

Torsten Slok, a partner and chief economist at US-based asset management firm Apollo Global Management, said interest rates are expected to remain relatively higher for longer, even if the Fed begins a monetary easing cycle.

"If we assume the interest rate futures market is correct in pricing in at least four rate cuts in 2024—which we believe is overblown—short-term interest rates would by the end of 2024 be around 4.5%, a level that would still be the highest for overnight rates since 2007 (excluding the Fed’s current hiking cycle)," he said in an email.

"Furthermore, if we take in the expectations for an additional five rate cuts in 2025, rates will reach 3% by the end of next year, which is nearly double the average 1.8% rate over the past decade," he added.

The Fed indicated Wednesday that it may cut interest rates by an additional 50 basis points by the end of this year, according to its latest projection materials.

The bank may lower interest rates four more times by 25 basis points each next year, and two additional times by 25 basis points each during 2026, the projections showed.

"Our expectation remains that it will take longer for inflation to come down to the central bank’s 2% target range, and as a result, the curve will continue to steepen, meaning long rates are going to decline less than short rates," Slok said.

- 'Rate cut could help extend uptrend in gold'

Bas Kooijman, CEO and asset manager of Luxembourg-based asset management company DHF Capital, said the Fed's interest rate decision came "as a boost" to the gold market and drove prices to a new high.

He said the decision acts as a beginning for the interest rate cutting cycle that markets have been waiting for a long time, and it could "fuel appetite" for assets like gold.

"The 50-basis-point rate cut could help extend the current uptrend in gold prices, which could continue to see new records thanks to other additional supporting factors," he wrote in an email.

"The size of the cut also opens the way for more aggressive actions in the coming months," he added.

Kooijman noted that the Fed’s dot plot shows a steeper decline in interest rates than previously forecast by the central bank, and this trajectory could "further cement" gains in gold prices.

The median projection for the federal funds rate showed 4.4% for this year, down from a 5.1% projection made in June.

Likewise, the median projection for the federal funds rate stood at 3.4% for 2025, down from a previous estimate of 4.1%, and at 2.9% for 2026, down from 3.1%.