Interest rate forecast 2025: Consumers can expect lower rates

Article originally posted on on October 30, 2024

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Key Points

  • The Federal Reserve recently cut interest rates for the first time in four years.
  • Interest rate cuts make mortgage, automobile and other loans more affordable.
  • Economists expect more interest rate cuts in 2025 and 2026.

The federal funds rate, determined by the U.S. Federal Reserve, is a crucial interest rate for Americans. It indirectly influences mortgage rates, credit card rates, business loans and more. Additionally, it affects the yield savers earn on savings accounts and certificates of deposit.

The outlook for interest rates in 2025 and 2026 depends mainly on the U.S. economy. Assuming no inflation rebounds, economists anticipate interest rates will continue to fall.

Interest rate cuts

The Federal Open Market Committee reduces the federal interest rate to stimulate the economy or restore monetary policy to normal levels. Lower borrowing costs for consumers and businesses promote economic growth and job creation.

Companies are more inclined to invest in expansion when borrowing is cheaper. Similarly, lower credit card rates encourage Americans to spend more. During economic downturns, rate cuts are an invaluable tool for the Fed to support the economy.

What does an interest rate cut mean?

An interest rate cut means that a central bank, like the Federal Reserve in the U.S., lowers the amount it charges banks to borrow money. This rate, often called the policy rate, influences almost all other rates, including those on personal and business loans.

Rate cuts can have an immediate impact on the average American.

“Lower interest rates can make housing and financing cars more affordable,” said David Russell, global head of market strategy at TradeStation.

Higher corporate earnings may also help Americans’ equity investments. “Lower rates may help the stock market, which can support retirement accounts and employment,” Russell said. The downside is that deposit account yields decrease.

Understanding Fed interest rate decisions

The Federal Reserve operates under a dual mandate. Any changes the Fed makes to monetary policy are intended to maximize employment and stabilize prices.

On the employment front, the Fed wants to support job creation and workforce participation. On the price stability front, the Fed targets 2% price inflation.

If the economy grows too quickly, inflation may overheat. In that scenario, the Fed can raise interest rates to cool it down. If the economy slows and layoffs accelerate, the Fed can cut interest rates to support the economy.

The FOMC typically meets eight times per year to make policy decisions. But it can call an emergency policy meeting at any time.

Why is the federal interest rate so influential on other interest rates?

The fed funds rate establishes the interest rate banks charge each other for overnight loans. It is the baseline rate used for all other types of loans and interest rates. Typically, banks adjust their interest rates in response to changes in the fed funds rate, often moving in the same direction.

Each bank sets its prime rate, typically 3% higher than the fed funds rate. Banks use their prime rate to determine what they charge on credit cards, mortgages and other loans. They also use it to determine savings and CD rates.

Current interest rates

The target U.S. fed funds rate is between 4.75% and 5%. The prime rate is around 8% — the high end of the fed funds target range plus 3 percentage points. While this is a decline from the recent peak of 5.25% to 5.50%, it is still relatively high.

The fed rate dropped to near zero after the 2008 financial crisis and stayed there for nearly a decade. After rising to a range of 2.25% to 2.50%, it fell to near nothing again after the COVID-19 outbreak. However, it remained depressed for a shorter period. The Fed began increasing rates in March 2022.

Despite some outcry, the Fed kept rates elevated to fight inflation. In September 2024, it made the first rate cut in four years.

Interest rate forecast 2025

Assuming inflation remains near 2%, interest rates will likely continue to trend lower. The FOMC projects a fed funds rate of just 3.4% by the end of 2025. With that, experts say Americans should expect lower interest rates in 2025.

“The expectation of the vast majority of market participants is that the Federal Reserve will continue to lower interest rates through 2025,” said Robert Johnson, chartered financial analyst and finance professor at Creighton University’s Heider College of Business.

According to CME Group, the bond market is pricing in a nearly 69% chance that the fed funds rate will drop to 3.50% to 3.75% or less by the end of 2025.

“Interest rates will likely fall, and fall substantially, in 2025 and beyond,” Johnson said.

Interest rate forecast 2026

Economists anticipate interest rates will drift lower at a slower pace in 2026.

The FOMC projects fed funds rates of 2.9% at year-end 2026 and 2027. Those projections indicate two rate cuts of 25 basis points each in 2026. They also suggest the fed funds rate will remain at around 2.9% after that.

Economists say stabilized inflation can lead to stable interest rates.

“While I believe that the world of extremely low rates is over, that doesn’t necessarily mean that the opposite condition of stiflingly high interest rates must take its place. What is more likely is a period of stability,” said David Lundgren, chartered financial analyst and chief market strategist at Stirlingshire.

Interest rates worldwide

Each central bank worldwide is responsible for setting its own interest rates. But most governments and central banks worldwide reacted similarly to the COVID-19 pandemic.

As a result, interest rates fell to historically low levels in 2020 on a global scale. Stimulus measures and supply chain disruptions triggered post-pandemic inflation in many developed countries. The U.S. was far from the only country forced to raise rates to get prices under control.

How does the U.S. compare with other countries?

Heading into 2025, the U.S. fed funds rate is comparable to several other leading countries. U.S. interest rates are certainly not the lowest worldwide, but they are far lower than those of other major countries still dealing with inflation.

Here’s how U.S. interest rates compare to several other major countries and economic regions:

What can we expect from the next Fed meeting?

The next Fed interest rate decision will be made after the FOMC meeting on Nov. 7.

At its upcoming meeting, the Fed must decide whether to lower interest rates again. This will largely depend on the inflation trends observed in September, as the consumer price index data for October will not be available before the meeting.

The meeting minutes are released three weeks after each meeting, providing additional insight into what FOMC members discuss.

 

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