The US Federal Reserve began cutting interest rates on Wednesday, signaling a turning point in the long-standing fight against inflation.

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Win McNamee/Getty Images North America

The US Federal Reserve began cutting interest rates sharply on Wednesday as inflation fears gave way to growing concerns about the labour market.

The central bank cut its key interest rate by half a percentage point, making it cheaper to take out a car loan, finance a business or carry a balance on a credit card.

Wednesday’s rate cut is the Fed’s first since 2020, but it won’t be the last. On average, members of the Fed’s interest rate committee expect borrowing costs to fall another half a percentage point this year and another full percentage point next year. That’s a faster decline than committee members had forecast just three months ago.

The move to lower interest rates marks a major turning point in the Fed’s two-and-a-half-year battle to curb inflation. The central bank began raising interest rates in March 2022 to dampen demand and bring prices under control. By last summer, rates had risen to 5.25 to 5.5 percent, the highest level in more than two decades.

Inflation is slowing – but so is the labour market

Wednesday’s rate cut came as annual inflation has fallen sharply, from a peak of 9.1% in June 2022 to 2.5% last month.

At the same time, job growth slowed and the unemployment rate rose to 4.2%. Fed officials therefore fear that high interest rates could become an unnecessary burden on the economy.

“The upside risks to inflation have declined. And the downside risks to employment have increased,” Fed Chairman Jerome Powell said last month during a speech in Jackson Hole, Wyoming. “It’s time to adjust policy.”

The pace of future interest rate cuts is still uncertain, however. Committee member Michelle Bowman wanted to proceed more cautiously on Wednesday and only lowered the key interest rate by a quarter of a percentage point. Committee members are divided on how much interest rates will need to be cut further next year.

While falling interest rates help borrowers and potentially stimulate economic growth, they also come at a cost to savers. Rates on online savings accounts and money market funds are likely to fall.

The timing of the Fed’s move is politically sensitive, coming less than seven weeks before a presidential election in which the strength of the economy is a key issue for voters. Powell has repeatedly said that he and his colleagues are trying to do what is best for the economy and are not influenced by partisan political considerations.