The Federal Reserve began cutting interest rates on Wednesday, marking a turning point in the long-running battle against inflation.

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Win McNamee/Getty Images North America

The Federal Reserve responded aggressively on Wednesday by cutting interest rates as easing inflation fears give way to growing concerns about the labor market.

The central bank has cut its key interest rate by half a percentage point, making it cheaper to take out a car loan, finance a business or carry a balance on your credit card.

Wednesday’s rate cut is the Fed’s first since 2020, but it won’t be the last. On average, members of the Fed’s rate-setting committee expect borrowing costs to fall another half a percentage point this year and a full point next year. That’s a faster decline than committee members predicted three months ago.

The move to lower rates marks a major turning point in the Fed’s two-and-a-half-year battle to tame inflation. The central bank began raising rates in March 2022 in an effort to dampen demand and get a handle on prices. By summer, rates had risen to between 5.25% and 5.5%, the highest level in more than two decades.

Inflation is falling, but so is the labor market

Wednesday’s rate cut comes after annual inflation fell sharply, from a peak of 9.1% in June 2022 to 2.5% last month.

At the same time, job growth has slowed and the unemployment rate has risen to 4.2%. Fed officials fear that high interest rates will put an unnecessary drag on the economy.

“The upside risks to inflation have diminished. And the downside risks to employment have increased,” Fed Chairman Jerome Powell said last month during a speech in Jackson Hole, Wyo. “It is time for policy to adjust.”

The pace of future rate cuts is still uncertain, however. A member of the committee, Michelle Bowman, wanted to be more cautious on Wednesday, cutting the benchmark rate by just a quarter of a percentage point. Committee members are divided on how much further rates should fall next year.

While falling interest rates will help borrowers and potentially stimulate economic growth, they come at a cost to savers. The interest paid on online savings accounts and money market funds is likely to fall.

The timing of the Fed’s move is politically sensitive, coming less than seven weeks before a presidential election in which the strength of the economy is a key issue for voters. Powell has said repeatedly that he and his colleagues are trying to do what’s best for the economy and are not influenced by partisan politics.