The latest data from the Bureau of Labor Statistics confirm that the Federal Reserve has made a lot of progress on inflation. The Consumer Price Index (CPI) grew 2.3 percent over the past year. It has grown at an annualized rate of just 1.6 percent over the past three months. Despite this progress, however, Fed officials voted to hold the federal funds rate target range at 4.25 to 4.5 percent last week.

When will the Fed begin cutting interest rates — and how far will rates fall this year? The short answers are “not soon” and “not much.”

The Fed is currently in a holding pattern, awaiting further clarity on the fallout from President Trump’s trade war. On the one hand, lower inflation readings would seem to warrant a lower interest rate target. Recall that the real (inflation-adjusted) federal funds rate target is equal to the nominal target set by the Fed minus expected inflation.

To the extent that they coincide with lower inflation expectations, lower inflation readings result in a passive tightening of monetary policy as they push the real federal funds rate target up. To prevent policy from tightening further in the face of falling inflation, the Fed must lower its federal funds rate target.

On the other hand, Fed officials are worried that higher tariff rates introduced by the Trump administration might unanchor inflation expectations. Fed Chair Jerome Powell summarized the anticipated effects of higher tariff rates at the post-meeting press conference last week:

If the large increases in tariffs that have been announced are sustained, they’re likely to generate a rise in inflation, a slowdown in economic growth, and an increase in unemployment. The effects on inflation could be short-lived, reflecting a one-time shift in the price level. It is also possible that the inflationary effects could instead be more persistent. Avoiding that outcome will depend on the size of the tariff effects, on how long it takes for them to pass through fully into prices, and ultimately on keeping longer term inflation expectations well-anchored.

Powell made it clear that the Fed’s “obligation is to keep longer term inflation expectations well anchored and to prevent a one-time increase in the price level from becoming an ongoing inflation problem.”

The tariffs are, in effect, an adverse supply shock, similar to the adverse supply shock caused by COVID-19 in 2020. The Fed could not prevent the disease from spreading or rescind stay-at-home orders in 2020. It cannot repair supply chains disrupted by higher tariff rates today. The best it can do is look through the adverse supply shock and keep nominal spending on a stable trajectory. Its failure to do this beginning in 2021 resulted in above-target inflation. The Fed does not want to repeat that mistake.

Here’s the problem: although disinflation warrants reducing the federal funds rate target, that move could be misconstrued as an attempt to offset the decline in economic growth associated with the higher tariff rates. If the public expects the Fed to deliver an expansionary monetary policy in response to the adverse supply shock, inflation expectations will rise and potentially become unanchored. To avoid that, the Fed is holding its federal funds rate target steady for now and assuring the public that it will not attempt to offset a tariff-induced contraction.

How long will the Fed maintain its holding pattern? Prior to last week’s meeting (and Powell’s commentary), markets expected the Fed would likely cut its federal funds rate target in July. On May 6, 2025, the CME Group reported futures markets were pricing in a 77.7 percent chance that the federal funds rate target would be at or below 4.25 percent following the July meeting.

Now, it reports the odds at just 36.8 percent.

More likely, the Fed will begin cutting interest rates in September. The CME Group now reports 74.5 percent odds that the federal funds rate target will be lower following the September meeting.

Figure 1. Probabilities of changes to the federal funds rate following September FOMC meeting, as implied by 30-Day Fed Funds futures prices; CME Group

Back in March, the median Federal Open Market Committee member projected that the federal funds rate would fall 50 basis points by the end of this year. That still looks likely.

According to the CME Group, there is currently a 22.8 percent chance that the federal funds rate target is 25 basis points lower following the December meeting; a 38.0 percent chance it is 50 basis points lower; and a 26.7 percent chance it is 75 basis points lower. All told, the futures market is pricing in a 72.3 percent chance the Fed’s target rate is lower by at least 50 basis points by the end of the year. FOMC members will submit revised projections in June.

Figure 2. Probabilities of changes to the federal funds rate following December FOMC meeting, as implied by 30-Day Fed Funds futures prices; CME Group

Ultimately, the Fed’s interest rate decisions will depend on the incoming data — and the clarity those data bring.

“For the time being,” Powell said last week, the Fed is “well positioned to wait for greater clarity before considering any adjustments to our policy stance.”

However, Odeta Kushi (pictured top), deputy chief economist at First American, can see where the Fed is coming from with its likely decision to hold rates steady on Wednesday.

“The Federal Reserve is widely expected to hold rates steady at (this) week’s meeting,” Kushi told Mortgage Professional America. “Markets have priced in a ‘wait-and-see’ approach, and the Fed seems inclined to delay any cuts until they have greater clarity on how tariffs and broader economic trends are evolving, likely not before September.”

Inflation progress not enough for Fed

Kushi believes that the FOMC will continue to stress that its economic indicators, while improving from earlier this year, still aren’t in range to the point where the Fed feels comfortable with a rate cut.

“The Fed will almost certainly emphasize its data-dependent stance,” Kushi said. “Inflation has cooled considerably, and there are reasons to believe that it could continue to cool. Notably, shelter inflation is likely to ease further, as it tends to lag behind market-based rent trends, and in the labor market, a lower quits rate suggests wage growth is slowing.

“But the progress on inflation isn’t enough for the Fed to feel confident that inflation risks are behind us, especially with new tariffs introducing potential upside pressure. And, while the labor market has shown some cracks, its resilience gives the Fed time to ‘wait and see.’”

Global investment bank JP Morgan perhaps put it best in a note to clients and the media this week titled “Australian CPI: Under control”.

Domestic inflation does appear to be under control. The prices of particularly sticky items in the basket measured by the Australian Bureau of Statistics are coming off the boil.

And stronger economic growth, according to the federal budget, is reliant on a renewed confidence in the private sector struggling with high levels of uncertainty about the future.

And overnight, those uncertainties — at least as far as they relate to global financial risks — came to the fore. Fear gripped Wall Street as fresh data showed rising recession fears.

The yield on the US 10-year Treasury bond plunged 11 basis points to 4.25 per cent early on Saturday morning — a clear sign of heightened economic fears.

On some measures, the Reserve Bank’s goal of lowering inflation to be within the target band of 2 and 3 per cent has been achieved.

With little risk of inflation spiking higher, the RBA could comfortably move to cut interest rates on Tuesday.

But it’s highly unlikely to do so, and it’s worth exploring why.

Progress on inflation

Significant progress has been made on reducing inflation.

Core or underlying inflation peaked in December 2022 at 7.8 per cent. The latest measure (December 2024) puts it at 3.2 per cent.

The Reserve Bank and households can all take credit for this.

The budget says Australia’s on track for a ‘soft landing’ Photo shows Jim Chalmers holds his arms out while speaking at a press conference at parliament house The forecasts in the federal budget paint a rosy picture of the future, claiming the mythical “soft landing” is “increasingly likely” for Australia’s economy.

Restrictive interest rates have curbed spending, reduced demand, and led to a reduction in price increases and, in some cases, discounting (deflation).

And measures of headline inflation — which includes so-called “volatile” items in the basket of goods and services measured by the ABS, look even better.

In the December quarter, annual headline inflation fell to 2.4 per cent, which is within the RBA’s target band.

The ABS’s Monthly Inflation Indicator (February) shows headline inflation at 2.4 per cent, and core inflation at 2.7 per cent.

Again, all within the Reserve Bank’s target band — although the monthly data sets are widely recognised as being insufficient to make a conclusive call on trend inflation.

However, taken with the above data, monthly inflation certainly supports the argument that inflation is “under control”.

Disinflation taking hold

The reason prices, more broadly, are not rising as fast now as they have been, is simple. The so-called “sticky” items in the ABS basket — including rental prices, the cost of building a new home, insurance premiums and out-of-pocket healthcare costs — are all looking less sticky.

Rental price growth, for example, has fallen to 5.5 per cent in the 12 months to February. It was above 6 per cent last year.

Insurance prices rose 7.6 per cent in the 12 months to February, while insurance price growth has continued to soften from its peak of 16.5 per cent 12 months ago.

And out-of-pocket healthcare costs, with an inflation rate of 4 per cent, have remained unchanged now for months.

Petrol has gone from inflationary to deflationary.

Petrol has gone from inflationary to deflationary. (AAP )

The one item in the basket that stands out is electricity.

Indeed, trimmed mean inflation of 3.2 per cent recorded in the December quarter “excluded the falls in both electricity and automotive fuel, alongside other large price rises and falls”, the ABS said.

This is because the price reductions, in the case of electricity, were largely engineered by the government.

The Reserve Bank rises above all of this. It says it wants to see underlying or “core” inflation sustainably within the target band.

For this to happen, it says, total or aggregate supply in the economy needs to be greater that total or aggregate demand.

Hot or not?

Surely this (supply outstripping demand) must have happened because the Reserve Bank has already started cutting interest rates?

Not quite. An RBA easing policy has not commenced.

At its February interest rates decision, where it lowered the cash rate from 4.35 per cent to 4.1 per cent, the central bank stressed that it was simply undoing or unwinding its December 2023 interest rate hike.

The bank concedes it doesn’t know whether demand in the economy is still greater than supply.

Unemployment rate steady despite job losses Photo shows A number of people cross an intersection in Brisbane’s CBD. Behind them are office buildings. Australia’s unemployment rate remained steady at 4.1 per cent in February, as labour force participation declined from a record high.

And it points to the relatively tight labour market as a possible signal there is too much demand.

To put it simply, there’s a level of unemployment which is, for want of a better phrase, inflation neutral.

The RBA is unsure if the current unemployment rate is inflation neutral or not, but it’s leaning towards not.

Its forecasts show “full employment” — which is another way of measuring this “non-accelerating inflation rate of unemployment” (NAIRU) — is 4.5 per cent.

But this week’s federal budget papers suggest it’s lower than that, at 4.25 per cent.

AMP says it’s even lower at 4.1 per cent, where it sits presently.

All about core inflation

But there’s one data point that we cannot escape: the March quarter ABS Consumer Price Index. This is what the Reserve Bank is waiting for.

If it shows core inflation is at the top of, or within its target band, the RBA will likely lower interest rates further.

So why does the bank need to wait for this data? Because its policy has shifted in recent years to lean heavily on data.

“Monetary policy changes can take time to affect the economy,” the RBA has noted.

“That is why the Reserve Bank has tended to look to what inflation is forecast to be in the future when deciding on the stance of monetary policy today.

The RBA is waiting for the March quarter ABS Consumer Price Index. (Reuters: David Gray)

“In recent years, however, the Reserve Bank has stated that it will focus more on actual inflation outcomes, rather than its forecasts for inflation, when deciding whether to adjust the cash rate.”

The obvious reason for this is to avoid being in a position where the bank cannot cover itself for a policy mistake.

In the event of a cutting cycle, for example, the RBA could point to a better-than-expected first quarter inflation outcome if it was criticised later for easing policy too early.

The RBA is still bruised after copping criticism when former governor Philip Lowe suggested, in the early years of the pandemic, that interest rates may not rise until 2024, followed reasonably quickly by one of the steepest tightening cycles in the bank’s history.

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Is cost-of-living relief urgent or not?

But is this fair when millions of households are still struggling to make ends meet?

This struggle is largely related to housing costs stress and paying for healthcare and insurance — which have little to do with “demand” in the economy. Mortgage stress is also hurting families.

Both major parties are also aware of households’ financial stress and desperation and are spruiking cost-of-living relief as the election campaign gets underway.

Labor is selling hip pocket help in the care arena, for energy bills, as well as in relation to personal income tax, while the Coalition is marketing its financial help for small business, motorists, and energy consumers in the longer term.

From students to pensioners, here’s what the budget means for your bills Photo shows a close-up of a person holding several pages of a household power bill in their hands. Changes to Medicare, fresh tax cuts and more energy bill relief — here’s what the federal government’s latest budget means for the cost-of-living crisis.

There’s another obvious source of financial relief for at least a third of Australian households — an RBA interest rate cut — but don’t hold your breath for that.

“Despite cutting the cash rate from 4.35 per cent to 4.1 per cent in February, the post-meeting commentary, comments in the Statement on Monetary Policy which updated the RBA’s forecasts and speeches from RBA officials sounded hawkish, implying that further rate cuts are not necessarily on the horizon,” AMP’s chief economist Shane Oliver wrote.

Meanwhile, ANZ Bank noted: “The first meeting of the new RBA Monetary Policy Board, which features two new members, should pass with no change to the cash rate.”

HSBC said: “We expect the RBA to be firmly on hold in April, but the global backdrop presents considerable risks to the outlook.”

RBC Capital Markets, however, is one of the few banks to reference the election campaign in its interest rates commentary.

The headline to its latest client note read: “PM calls an election for 3 May, another reason for the RBA to leave rates steady next week.”

Why would politics influence an RBA interest rates decision, especially when most economists agree the election outcome won’t influence the inflation trajectory?

The April dilemma

Herein lies the RBA April interest rate decision dilemma. Some analysts argue the bank has a strong case to cut the cash rate but is unlikely to do so in the middle of an election campaign.

The Reserve Bank also appears to be waiting for a data point — the March quarter CPI — that measures past price movements, despite lower inflation as well as other evidence pointing towards a weak economy which is unsustainably being supported by the public service.

And global economic threats persist, which economists argue point to further weakness in inflation.

A quarter of a percentage point cut to the cash rate would save a mortgage borrower on a variable $750,000 loan, assuming a 25-year term, roughly $100 per month.

Why is the Reserve Bank waiting for a single historical data point at the same time a federal election is being framed around the cost of living?

There isn’t any time to waste helping households stay afloat.

The Fed’s chairman Jerome Powell signalled it is likely to hold rates steady until it sees more progress on lowering inflation as it awaits more details on Trump economic plans. PHOTO: HAIYUN JIANG/NYTIMES

Powell tells US Congress Fed still in no rush to lower interest rates, well positioned for risks

WASHINGTON – Federal Reserve chairman Jerome Powell said the US central bank does not need to rush to adjust interest rates, again signalling that officials will be patient before lowering borrowing costs further.

“With our policy stance now significantly less restrictive than it had been and the economy remaining strong, we do not need to be in a hurry to adjust our policy stance,” Mr Powell told the Senate Banking Committee on Feb 11.

“We know that reducing policy restraint too fast or too much could hinder progress on inflation,” he said. “At the same time, reducing policy restraint too slowly or too little could unduly weaken economic activity and employment.”

Mr Powell’s comments largely echoed remarks he gave in January after Fed policymakers left the US central bank’s key policy rate unchanged.

Treasury yields moved to their highs of the day as Mr Powell spoke, while stocks pushed higher. Investors also largely left unchanged their expectations for rate cuts in 2025, with a cut not fully priced until September and fewer than two cuts priced in for all 2025.

That decision came after the US Federal Open Market Committee lowered interest rates at each of its last three meetings in 2024. Mr Powell and other Fed officials have signalled they are likely to hold rates steady until they see more progress on lowering inflation, and as they await further details on US President Donald Trump’s economic-policy plans.

Mr Trump’s policy proposals, meanwhile, have added a layer of uncertainty to the economic outlook. The Trump administration has ramped up tariffs on goods from China, and on all imports of steel and aluminium, threatened additional duties on Canada and Mexico, and launched a promised immigration crackdown.

Those measures could put upward pressure on inflation, weigh on economic growth or constrict the number of available workers, all of which would likely have policy implications for the Fed. Some Fed officials have begun to factor Mr Trump’s policies into their forecasts for how the economy will evolve, while others have said they have not yet seen enough details on the plans to do so.

“We are attentive to the risks to both sides of our dual mandate, and policy is well positioned to deal with the risks and uncertainties that we face,” Mr Powell said.

Lawmakers also probed Mr Powell on financial regulation, as Mr Trump advances a deregulatory push across the federal government. That push has already played a role in the coming resignation of Fed governor Michael Barr from being vice-chairman for supervision. Though he will stay on as a governor, Mr Barr has said he will step down from the regulatory post at the end of February, in part to avoid a clash with the new administration.

Mr Powell said he is hopeful a version of a long-awaited bank-capital plan could be reached “fairly quickly”, and would be in line with other large jurisdictions and consistent with international accords. “We remain committed to completing Basel III Endgame. We think it’s good for US banks, it’s good for our economy that there be a global standard beneath which foreign banks can’t fall,” said Mr Powell.

Lawmakers repeatedly pressed Mr Powell about the impact of a diminished Consumer Financial Protection Bureau (CFPB). Democratic Senator Elizabeth Warren of Massachusetts asked him who is responsible for examining giant banks to make sure they are not cheating consumers in the absence of the consumer watchdog agency.

“No other federal regulator,” Mr Powell responded.

The questions come after billionaire Elon Musk, who is acting as an adviser to the Trump White House, helped to effectively shut down the CFPB in February.

Mr Powell also told lawmakers the US central bank makes no decisions related to outgoing government payments.

“We make no judgments whatsoever. Those are all made upstream from us,” Mr Powell said, adding that the Fed acts as the Treasury Department’s fiscal agent, processing federal payments on its behalf.

Asked whether the system is safe, Mr Powell said: “I believe it is.”

Mr Powell’s comments come as the Treasury has landed in the spotlight in recent weeks after members of Mr Musk’s government efficiency team were given access to government payment systems at the department. Mr Powell said he did not believe members of the so-called Department of Government Efficiency, or Doge, had tried to access the Fed’s systems.

Mr Powell is set to appear before the House Financial Services Committee on Feb 12. BLOOMBERG

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The Federal Reserve kept interest rates at its target range of 4.25% to 4.5%, but policymakers said they still see two rate cuts coming in 2025. Their economic outlook also called for higher inflation and lower economic growth.

At his press conference, Fed Chair Jerome Powell said a “good part” of the central bank’s higher inflation expectation comes from tariffs.

He also noted that while economists outside of Fed have generally raised their estimated likelihood of a recession, a severe downturn still isn’t likely. Stocks surged to their highs of the day while Powell spoke at the podium.