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Scott Horsley

The Federal Reserve holds interest rates steady but signals rate cuts may be coming

Fed Chair Jerome Powell speaks during a news conference after the concludion of the Fed's policy meeting in Washington, D.C., on Sept. 20, 2023. The Fed held interest rates steady on Wednesday but indicated it could cut rates this year while also noting it would move cautiously. (Chip Somodevilla/Getty Images)

The Federal Reserve held interest rates steady on Wednesday but signaled that rates could fall in the coming months if inflation continues to cool.

Policy makers have kept their benchmark interest rate between 5.25% and 5.5% — the highest in over two decades — since July.

Fed chairman Jerome Powell told reporters Wednesday that interest rates are unlikely to go any higher, and that he and his colleagues are beginning to contemplate cutting rates.

"If the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year," Powell said.

He cautioned, however, that the economy remains unpredictable and said the central bank would proceed cautiously.

"The economic outlook is uncertain and we remain highly attentive to inflation risks," Powell said.

The Fed has been pleasantly surprised by the rapid drop in inflation in recent months. Core prices in December — which exclude food and energy prices — were up just 2.9% from a year ago, according to the Fed's preferred inflation yardstick. That's a smaller increase than the 3.2% core inflation rate that Fed officials had projected in December.

If that positive trend continues, the Fed may be able to start cutting interest rates as early as this spring. First, though, Powell said he and his colleagues will need to see additional evidence that inflation is easing.

And he sounded doubtful about a rate cut at the Fed's next meeting in March as many investors in Wall Street had hoped for.

"Based on the meeting today, I would tell you that I don't think it's likely the committee will reach a level of confidence by the time of the March meeting," Powell said. "But that's to be seen."

The comments disappointed investors, with the Dow Jones Industrial Average tumbling 317 points.

Investors are still hopeful about a rate cut by the following Fed meeting in May, with markets putting the likelihood of that at better than 90%.

People shop at a home improvement store in Brooklyn, N.Y., on Jan. 25, 2024. The economy has been sturdier than expected over the last year while inflation has continued to ease. (Spencer Platt/Getty Images)

Good omens in the economy

Both the economy and the job market have performed better than expected over the last year, despite the highest interest rates since 2001. The nation's gross domestic product grew 3.1% in 2023, while employers added 2.7 million jobs

Unemployment has been under 4% for nearly two years. And average wages in December were up 4.1% from a year ago.

While that strong economy is welcome news for businesses and workers, it also raises the risk of reigniting inflation. As a result, Fed policymakers say they'll be cautious not to cut interest rates prematurely.

"We have history on this," Atlanta Fed president Raphael Bostic told the Rotary Club of Atlanta this month. "In the '70s, the Fed started removing accommodation too soon. Inflation spiked back up. Then we had to tighten. Inflation came down. Then we removed it again. Inflation went back up. And by the time we were done with that, all Americans could think about was inflation."

The Fed is determined not to repeat that '70s show. At the same time, waiting too long to cut interest rates risks slowing the economy more than necessary to bring inflation under control.

A report from the Labor Department Wednesday showed employers' cost for labor rose more slowly than expected in the final months of last year. Labor costs increased just 0.9% in the fourth quarter. That's a smaller increase than the previous quarter, suggesting labor costs are putting less upward pressure on prices.

Fed officials promised to keep an eye on upcoming economic data and adjust accordingly.

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