Key Points

  • The Federal Reserve cut its key interest rate by 25 basis points to a range of 3.5%-3.75% on Wednesday, with three committee members dissenting. Concerns about a weakening labor market outweighed worries that inflation would remain persistently above the 2% target level.
  • In the median projection of the dot plot, Fed officialsexpect only a 25-basis-point rate cut in 2026. They expect their preferred inflation gauge—the personal consumption expenditures price index excluding food and energy—to fall to 2.5% by the end of 2026, 0.1 percentage point lower than the September forecast. At the same time, they raised next year's economic growth forecast from 1.8% in September to 2.3%. Central bank officials also expect the unemployment rate to be 4.4% by the end of 2026, unchanged from the September forecast.
  • Fed Chair Jerome Powell said at the post-meeting press conference that given the "diminished momentum and some softening in the labor market, downside risks to employment have increased in recent months."

In-Depth Analysis

For months, Fed officials have been trying to strike a balance amid so-called "two-sided" risks: stubborn inflation and a softening labor market are simultaneously threatening its congressionally mandated dual mandate of price stability and maximum employment.

Lowering borrowing costs could stimulate inflation; keeping rates unchanged could fail to prevent a surge in unemployment. The previous 43-day government shutdown prevented policymakers from obtaining timely data to support confidence in monetary policy.

Powell said: "When weighing between employment and inflation goals, there is no risk-free path for policy."

Nevertheless, Powell still emphasized that the greater threat comes from the labor market. He noted that from June to September, the unemployment rate rose by 0.3 percentage points, average monthly nonfarm payroll growth turned negative, and both household and business surveys showed contraction on both the supply and demand sides of the labor market.

"Employment growth has slowed notably this year," Powell said. "A large part of the slowdown likely reflects slower labor force growth due to reduced immigration and declining labor force participation, though labor demand has also clearly softened."

The unemployment ratewas 4.4% in September, and has continued to edge higher over the past few months. Hiring activity across the broader economy has also declined. Meanwhile, inflation has remained stable at around 3% for several months.

Powell's remarks are consistent with the stance of theFederal Open Market Committee.

In its statement following the two-day meeting, the FOMC said: "Employment growth has slowed this year, and the unemployment rate has risen through September," adding that "downside risks to employment have increased in recent months."

Chicago Fed President Austan Goolsbee and Kansas City Fed President Jeffrey Schmid dissented, advocating for holding rates steady; while Fed Governor Stephen Miran dissented, calling for a 50-basis-point rate cut.

Powell said that despite the differences, policymakers agreed on the need to bring inflation down to 2% and avoid a labor market recession.

"Interestingly, everyone around the FOMC table agreed that inflation is too high and wants it to come down, and also agreed that the labor market has softened and faces further risks," Powell said.

"The disagreement is—how to weigh these risks, and what is your forecast?" he said. Also, "where do you see the greater risk?" he added.

Powell said that tariffs, the highest since the 1930s, have pushed inflation above 2%, but he also noted that price pressures from import tariffs should subside after the first quarter of 2026.

"Goods inflation is entirely concentrated in tariff-affected industries," he said.

Powell noted that since September 2024, policymakers have cumulatively cut the federal funds rate by 1.75 percentage points, bringing borrowing costs to a level that, according to various estimates, neither restrains nor stimulates economic growth.

"We are in a good position to wait and see how the economy evolves," he said.

Editor's Note: This article is an update to a previous report.