Federal Reserve keeps rates steady: Policy divergence with ECB widens!
The Federal Reserve decided to keep interest rates unchanged at a range of 4.25%-4.50% at its January meeting, in line with market expectations. After three consecutive rate cuts totaling one percentage point, the U.S. central bank's policymakers opted to hold off in their first policy meeting since the Trump administration took office.
The US economy remains resilient, with a strong labor market. However, inflation is still considered 'somewhat elevated', prompting the Fed committee to reiterate the cautious approach outlined in December: "In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the outlook for developments, and the balance of risks."
Essentially, the timing and extent of any further rate cuts will depend on economic data and emerging risks, a notion that had raised concerns among market participants last month.
The Fed continues to exercise caution, choosing to assess economic developments before implementing further monetary easing, a luxury not available to the European Central Bank, which faces growing pressure to cut rates more aggressively.
In December, the Fed surprised markets by raising its inflation forecast for 2025 to 2.5% and cutting its projection for interest rate cuts to just two this year, down from four in the September outlook. Fed Chairman Jerome Powell stressed that rates are close to neutral levels and that any further cuts should be treated with great caution.
While the strength of the US economy and persistent inflation are keeping Fed policymakers on edge, the situation in Europe is markedly different: the economic outlook is deteriorating and inflation is making steady progress toward the 2% target.
On Wednesday, the German government cut its economic growth forecast for 2025 to just 0.3%, from a previous estimate of 1.1% in October. Economy Minister Robert Habeck described the economic situation as "difficult" and warned that stagnation had persisted for a long time, exacerbated by labor shortages, excessive bureaucracy and insufficient public and private investment.
Market expectations currently point to two Fed rate cuts in 2025, starting in June, while the ECB is expected to implement four rate cuts by the end of the year.
Following the Fed's decision and ahead of Powell's press conference, the euro fell to 1.04 against the US dollar, reflecting the greenback's strength amid growing monetary policy divergence between the two economies. Powell is also likely to face questions about Donald Trump's renewed efforts to influence Fed decision-making.
Speaking via videoconference at the World Economic Forum last week, the newly elected US president explicitly stated that he would push for lower interest rates, a stance that could increase political pressure on the central bank in the coming months.
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