Another Fed interest rate cut increases inflation risks
Lena Dräger, Research Director of the Monetary Macroeconomics Group at the Kiel Institute, comments on the expected decision by the US Federal Reserve to lower the policy rate again:
"Another Fed interest rate cut and disagreement within the Federal Open Market Committee about the right monetary policy course increase the risks of a renewed rise in inflation. The interest rate cut is justified by a slight increase in the unemployment rate, which indicates a potential cooling of the labor market.
At the same time, the inflation rate remains well above the Fed's inflation target of 2 percent. The costs of US tariffs are unlikely to have been fully passed on to prices yet, which means that the inflation rate could rise even further in the future. The Fed's dual mandate—stabilizing inflation and the labor market—is therefore currently sending conflicting signals to monetary policy: To stabilize inflation, interest rates would have to be kept constant or even raised slightly, while a rate cut could stimulate demand and thus revive the labor market.
This explains the disagreement within the Federal Open Market Committee, the Fed's monetary policy decision-making body. Several members are expected to vote against an interest rate cut and at least one member is expected to vote in favor of a larger rate cut. This level of dissent is highly unusual and could undermine the Fed's credibility in the eyes of the public. It also increases the risk of a renewed rise in inflation if market participants do not expect a decisive response to rising prices and thus raise their inflation expectations.
To minimize inflation risks in the future, Fed Chairman Jerome Powell should make it clear in his monetary policy statement that further interest rate cuts in 2026 will depend on the dynamics of inflation. President Trump has been vehemently calling for further and larger interest rate cuts for months and is expected to appoint a successor to Powell who is more inclined to comply with these demands. Chairman Powell should therefore use the last months of his term until May 2026 to stabilize inflation dynamics in the US as much as possible close to the inflation target."
