Sticky Inflation Stokes Rift Within the Fed Over How Much Rate to Cut

Federal Reserve leaders remain united in their mission to combat the highest inflation levels in 40 years, but there’s growing division over how high U.S. interest rates need to remain to achieve this goal. This debate has taken center stage as officials grapple with the path forward for monetary policy.

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Last week, the central bank enacted its third interest rate cut of the year, with near-unanimous support. However, divisions among senior policymakers became evident regarding the appropriate level of interest rates in the coming years. These differing perspectives reflect varying assessments of how aggressively the Fed should act to bring inflation closer to its 2% target and the extent to which interest rates need to stay elevated to ensure success.

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“There is no hint of consensus,” noted Chris Low, chief economist at FHN, referring to the wide range of forecasts for the federal funds rate in 2026. Among the top Fed officials, projections varied from 3.1% to 3.9%, underscoring the uncertainty about future rate levels. This internal split is being closely watched by Wall Street, even if it feels less immediate to the general public.

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Not long ago, inflation appeared to be steadily approaching the Fed’s 2% target. The personal consumption expenditures (PCE) index, the Fed’s preferred measure of inflation, dropped to 2.1% in September—the lowest in 3½ years—down from its 2022 peak of 7.3%. However, recent monthly inflation reports have surprised to the upside, pushing the annual rate back up to 2.4% as of November.

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Fed officials now believe inflation could end 2025 slightly higher than previously anticipated, revising their projection for that year to 2.5%. “Inflation is proving to be more stubborn than many had anticipated,” observed Richard Moody, chief economist at Regions Financial. This persistence is complicating the Fed’s efforts to ease interest rates.

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In fact, the Fed has already reduced the number of projected rate cuts for 2025. Officials now foresee only two rate reductions, half the number expected just a few months ago in September. The prospect of sustained high borrowing costs could have wide-reaching implications for homebuyers, businesses, and consumers alike.

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The divisions within the Fed were made clear in the so-called “dot plot,” which illustrates the views of 19 senior officials, including seven board members and 12 regional bank presidents. Notably, four officials opposed last week’s rate cut, with new Cleveland Fed President Beth Hammack dissenting in the 10-1 vote. Such dissent is relatively rare within the central bank.

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Hammack expressed skepticism about the progress on inflation, stating that price pressures remain elevated and recent progress toward the 2% target has been uneven. She also suggested that the Fed may already be close to the "neutral rate"—the level of interest rates that neither accelerates nor slows economic growth. If true, this could imply that only modest rate cuts, amounting to 50 to 75 basis points, might be warranted.

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Opinions differ widely on where the neutral rate lies. Hammack is part of a group of six officials who believe the Fed is nearing neutral. In contrast, eight officials, likely including Fed Chair Jerome Powell, estimate the neutral rate is much lower, perhaps 3% or less. New York Fed President John Williams, a key ally of Powell, remarked, “I don’t think we are at the long-run neutral rate at all.” He suggested that while the neutral rate might be slightly higher than earlier estimates, it is still far below current levels.

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A smaller faction of Fed officials sees even more room for rate cuts, driven by concerns about economic growth and labor market stability.

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The future direction of interest rates will hinge on inflation trends over the next year. If the recent uptick in inflation proves temporary, the Fed could consider more aggressive rate cuts, potentially increasing the number of reductions in 2025. Chicago Fed President Austan Goolsbee expressed optimism, stating, “Over the next 12 to 18 months, rates can still go down a fair amount.”

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Some officials, including Goolsbee, are more focused on the risks to the labor market. These policymakers argue for faster rate cuts to prevent a potential rise in unemployment and to sustain the economic expansion, even if inflation remains slightly above target. San Francisco Fed President Mary Daly emphasized this perspective, saying, “I don’t want to see a rise in the unemployment rate just to get a quarter ahead on our 2% goal.”

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Fed Chair Powell faces the delicate task of uniting these divergent views while navigating external pressures, including the return of President-elect Donald Trump, a vocal critic of Powell during his first term. However, debates within the Fed are typically measured and collegial, and Powell enjoys broad support among his colleagues.

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Historically, it’s rare for a Fed chair to lose a key vote or face significant dissent. The last instance of a Fed chair losing a vote occurred in the 1980s under Paul Volcker, during one of the most turbulent periods in U.S. economic history.

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While internal divisions persist, the Fed’s commitment to taming inflation remains steadfast. The path forward, however, will depend on how inflation evolves and whether the central bank can strike the right balance between curbing price pressures and supporting economic growth.

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