Federal Reserve wrestles with decision over how aggressively to cut

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The Federal Reserve faces a close call over whether to cut US interest rates by a larger-than-expected half-point next week or go with a quarter-point move, as officials wrestle with how quickly to ease monetary policy.

The uncertainty at the central bank over the size of the cut comes as futures markets increasingly price in a more modest quarter-point reduction from the Fed when its pivotal meeting concludes on Wednesday.

Any cut next week would be the Fed’s first in more than four years, and after holding rates at a 23-year high of 5.25-5.5 per cent since last July, would come with seven weeks until November’s presidential election.

Top Fed officials have backed a series of interest rate cuts amid signs inflation is easing and as they focus on preventing undue economic damage from keeping borrowing costs higher than needed.

But there is a debate among officials about how quickly to cut rates next week and return to a “neutral” level that does not stymie growth.

A half-point rate cut in September would let the Fed return borrowing costs to normal levels more quickly, removing restraint on the economy and protecting the labour market from further weakness.

Policymakers have not raised alarm about the US’s economic outlook but have warned about rising downside risks. Several even thought it “plausible” to lower rates at the most recent meeting, minutes showed. Jobs and inflation data since then have become more supportive of cuts.

Fed chair Jay Powell said last month that the Fed would “do everything we can to support a strong labour market as we make further progress towards price stability”.

Fed governor Christopher Waller said last Friday that he was “open-minded about the size and pace of cuts” and would back a larger cut “if the data suggests the need”. But he said he expected any move would be “done carefully”.

Also on Friday, the New York Fed’s president John Williams said he was undecided on the size of this month’s cut but said the central bank was “well-positioned” to meet its inflation and jobs goals.

“We’ll get together and obviously analyse everything and discuss that,” he told reporters of the size of the first cut.

A more aggressive half-point cut by the Fed this month would bring risks, however. 

Recent data has been mixed, with the most recent jobs report showing slower monthly growth but also lower unemployment and rising wages. Inflation data this week showed price pressures were easing even as the “core” measure of the consumer price index that strips out volatile food and energy prices firmed.

A half-point move could also spark concerns that the central bank has grown worried about the economic outlook. It could also prompt financial markets to price in a more dramatic reduction in rates, beyond the Fed’s planned pace of easing.

“An argument can be made for 50 [basis points] but the communications around that are complicated and there isn’t a compelling reason to take on that challenge,” said Loretta Mester, who retired as the Cleveland Fed’s president in June.

A deeper-than-expected cut would also risk political blowback, given Republican presidential candidate Donald Trump has already warned the Fed against any cut in September, just a few weeks before the election.

Powell recently said the Fed would “never use our tools to support or oppose a political party, a politician or any political outcome”.

Futures markets suggest the Fed will lower rates by a percentage point by year-end, indicating one half-point reduction at one of the remaining three gatherings.