The U.S. Federal Reserve reduced its key interest rate by a quarter point on Wednesday, marking the third cut this year as it seeks to balance high inflation with economic growth. This adjustment lowers the benchmark rate to 4.3%, but the Fed signalled a slower pace of rate reductions in 2025 than previously anticipated.
Chair Jerome Powell highlighted that the decision reflects the central bank’s assessment of inflationary pressures and its proximity to the “neutral rate,” which neither stimulates nor restrains the economy. “We’re closer to the neutral rate, which is another reason to be cautious about further moves,” Powell said, adding that the Fed remains on track for additional cuts if needed.
Despite the adjustments, inflation remains well above the Fed’s 2% target, with core inflation—excluding volatile categories—at 2.8% in October. Powell emphasised that the economy’s robust growth has limited the impact of high borrowing costs, but the cooling labour market and rising unemployment warrant careful attention.
Slowing Rate Cuts as Inflation Persists
The Fed’s updated projections indicate just two quarter-point cuts in 2025, down from an earlier forecast of four. Powell noted that the slower pace reflects the resilience of inflation and the need to avoid over-stimulating the economy.
The central bank navigates a delicate path, aiming to curb inflation without tipping the economy into a recession. While the unemployment rate remains relatively low at 4.2%, it has risen nearly a whole percentage point in the past two years, raising concerns about potential job market strain.
Policymakers project inflation will rise slightly to 2.5% by the end of 2025, while unemployment is expected to rise to 4.3%. These projections underscore the Fed’s challenges in achieving its dual mandate of price stability and maximum employment.
U.S. Dollar Strengthens, Canadian Dollar Weakens
The Fed’s rate cut bolstered the U.S. dollar, outperforming other currencies, including the Canadian dollar. The loonie fell below 70 cents USD for the first time since March 2020 as investors flocked to U.S. markets, driven by high returns.
“Jerome Powell was talking about a U.S. economy that is outperforming not just domestic expectations but also the rest of the world,” said Karl Schamotta, chief market strategist at Corpay, a payment management firm in Toronto. He explained that the strength of the U.S. dollar creates challenges for the Canadian economy, including reduced competitiveness and higher costs for imported goods.
Additional factors contributing to the loonie’s decline include reduced global demand for Canadian energy exports, high household debt, and concerns over U.S. President-elect Donald Trump’s tariff threats. Trump has proposed a 25% tariff on Canadian goods, further heightening economic uncertainty.
Risks and Opportunities for Canada
While a weaker loonie challenges Canada’s exports and consumer sentiment, some industries may benefit. “A lower Canadian dollar allows exporters to sell cheaper goods to global markets, potentially boosting growth,” Schamotta said. However, the broader economic outlook remains clouded by risks, including the potential for recession if external pressures intensify.
The Canadian economy has struggled with the fallout from the end of a commodity supercycle and high borrowing costs. Analysts warn that further depreciation of the loonie could erode consumer confidence and slow business investment, adding strain to an already fragile economic environment.
Trump’s Policies Add Uncertainty
The Fed’s cautious tone reflects the uncertainty surrounding U.S. economic policy under President-elect Trump. Proposed tax cuts and deregulation could stimulate growth, while tariffs and mass deportations could exacerbate inflation.
Powell noted that it remains too early to gauge the full impact of Trump’s policies. “We can’t assess how the new administration’s policies might influence the economy or our rate decisions until more details are available,” he said.
Balancing Act for the Federal Reserve
The Fed’s approach underscores its effort to achieve a “soft landing” for the U.S. economy, where inflation is tamed without triggering a recession. While challenges remain, Powell reaffirmed the central bank’s commitment to responding to changing economic conditions.
For now, the Fed is signalling caution, prioritising stability over aggressive action as it navigates a complex economic landscape.