The Federal Reserve is expected to cut interest rates soon. Many will view such cuts as a surrender to pressure from Donald Trump. But the Fed must not become the president’s poodle. It needs to be careful about what it does.
In testimony to Congress this week, Jay Powell made the case for the Fed to cut rates, by emphasising “uncertainties about the outlook”. In response markets expect a cut of 25 basis points in July. Consensus forecasts, according to Bloomberg, are for one further cut this year. Some analysts forecast two more — which would bring rates back to where they were in May 2018. It would also mean that real short-term interest rates were close to zero, again.
Yet Mr Powell also insisted in his testimony that “our baseline outlook is for economic growth to remain solid, labour markets to stay strong, and inflation to move back up over time to the committee’s 2 per cent objective”. Gross domestic product increased at an annual rate of 3.1 per cent in the first quarter. This rate is above potential, as is shown by the continued fall in unemployment from 3.9 per cent in December 2018 to 3.7 per cent in June, which is “close to its lowest level in 50 years”.