WASHINGTON (AP) — Even as the economy undergoes what may be wrenching changes, the Federal Reserve on Wednesday is expected to signal it could cut its key interest rate twice this year — the same forecast it issued in December.
Yet the reasons for those cuts may change dramatically, depending on how the economy fares.
What were once seen as “good news” rate reductions in response to a steady decline in inflation back to the Fed's target of 2%, now could become “bad news” cuts that would be implemented to offset an economy struggling in the wake of widespread tariffs, rapid cuts in government spending, and a spike in economic uncertainty.
At the end of last year, the Fed reduced its key interest rate three times to about 4.3% from 5.3%. The Fed had rapidly raised its rate to combat inflation, and as price growth headed lower, that allowed the central bank to reverse some of those rate hikes. In September, inflation dropped to a 3 1/2 year low of 2.4%.
Yet inflation then marched higher for four straight months, before it finally fell back in February, to an annual rate of 2.8%. Partly because of that reversal, Chair Jerome Powell has underscored that the Fed is in wait-and-see mode as it evaluates the impact of President Donald Trump's policies on the economy.
So far, consumer sentiment has fallen sharply as Americans worry that inflation will rise in the coming months. Small business owners report a much more uncertain economic outlook, which can cause them to cut back on hiring and investment.
Retailers of both high-end and lower-cost goods have warned that consumers are turning more cautious as they expect prices to rise because of tariffs. Retail sales rose modestly last month after a sharp fall in January. Homebuilders and contractors expect that home construction and renovations will get more expensive.
On Tuesday, the Fed reported that manufacturing output jumped last month, driven higher by a spike in car production. Some of that could have reflected higher auto purchases by consumers looking to get ahead of tariffs. New home construction also grew faster than expected.
Many economists have sharply reduced their forecasts for growth this year, with Barclays, a bank, now forecasting growth of just 0.7%, down from 2.5% in 2024. And economists at Goldman Sachs now expect inflation — excluding the volatile food and energy categories — will tick higher to 3% by the end of this year, up from its current level of 2.6%.
Slower growth, if it also pushes up unemployment, and higher inflation would put the Fed in a very difficult spot. Typically, when companies start cutting workers, the Fed would reduce rates to spur more borrowing and spending and boost the economy.
Yet if inflation crept higher, it would want to keep rates elevated to slow growth and restrain inflation. When the Fed lifts its key interest rate, it tends to push other borrowing costs higher, including for mortgages, auto loans, business loans, and credit cards.
Economists will closely watch Powell's press conference Wednesday to see if he will signal how the Fed would handle such a situation.
But Powell will probably double-down on his recent efforts to underscore that the Fed can, for now, watch from the sidelines.
"The costs of being cautious are very, very low," Powell said earlier this month. "The economy's fine, it doesn't need us to do anything, really."
Separately, Christopher Waller, a member of the Fed's governing board, has previously said the Fed could still cut rates this year, even if tariffs were imposed, as long as inflation was still falling once the impact of was excluded.
Yet earlier this month, in an interview with the Wall Street Journal, he acknowledged teasing out tariffs' impact on prices would be difficult.
“You’re trying to find the signal of what’s fundamental, and what is maybe tariff noise," he said. "And that’s tough.”