The US Federal Reserve has cut its interest rate by 0.5 percentage points, bringing it to a range of 4.75% to 5%. This reduction, the first in over four years, signals an attempt to loosen the previous tight monetary stance which had been implemented to combat high inflation. This decision aligns with the Fed’s aim to promote employment and price stability.
This monetary easing comes after an extended period of contractionary policy. Beginning in 2022, the Fed aggressively raised rates to curb inflation, which had surged to 9.1%—the highest level in decades. These rate hikes operated through the credit channel, increasing the cost of borrowing for households and firms, thereby reducing consumption and investment. Now, with inflation dampening, the Fed’s rate cut is intended to stimulate economic activity by making credit more affordable, theoretically expanding both consumption and investment.
Many central banks, including those in the UK, the Eurozone, and Canada, have similarly began easing their monetary policies. The interest rate parity theory suggests that such movements can affect exchange rates, with lower US interest rates potentially weakening the US dollar against other currencies. This could influence the competitiveness of US exports and alter capital flows, as global investors seek higher returns elsewhere.
Australia, too, may feel the ripple effects of this decision. With the Reserve Bank of Australia maintaining a higher cash rate of 4.35%, the divergence in rates could place upward pressure on the Australian dollar, given that lower US rates might reduce the attractiveness of US assets. Governor Michele Bullock has indicated that the RBA’s approach, which has been more cautious than the Fed’s, is designed to curb inflation without inducing a recession.
Australia’s economy has begun to stabilise with inflation recovering at 3.9%, and unemployment at 4.2%. However, if the Fed continues to cut rates, the RBA may face pressure to respond, particularly if the exchange rate experiences volatile movements, impacting the cost of imports and exports.
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