The recent decision by the US central bank to raise key interest rates by 25 basis points, increasing the range to 3.75 to 4.00 per cent, was perceived as more significant than a mere routine rate adjustment. The central question was not primarily the interest rate level, but the assertion of the US central bank's monetary policy independence in the face of considerable political pressure. The Federal Open Market Committee (FOMC) made a unanimous decision, which can be interpreted as a clear signal. This occurred despite repeated calls from then-President Trump for interest rate cuts, with the committee collectively committing to a course primarily dedicated to price stability. President Trump's immediate and pronounced reaction highlighted the political sensitivity of the interest rate decision.
From an economic perspective, the interest rate hike was logical. US inflation had exceeded the two per cent target since 2021 and recently reached 3.4 per cent, while both the economy and the labour market remained robust. According to the Fed's assessment, inflation is not expected to approach the target again until the course of the following year. An unchanged key interest rate policy would have potentially increased financial market risks. It is assumed that yields on US government bonds would have risen further had the Fed decided against this rate hike. Equally, this could have heightened suspicions of fiscal dominance – a monetary policy subordinated to the government. Such a scenario would have made combating inflation more difficult and encouraged an uncontrolled rise in yields with negative consequences for equity and foreign exchange markets.
Credibility of Monetary Policy and Political Leeway
It is argued that, paradoxically, the Fed bought the US government time with this decision. The central bank preserved its monetary policy credibility and created scope for politicians to pursue a less expansive fiscal course, a correction of tariff policy, and progress in the Iran conflict. Whether the government would utilise this leeway could be demonstrated by the upcoming meeting between Donald Trump and Xi Jinping. Signals for de-escalation of the trade conflict or progress in resolving the Iran conflict could temper concerns about an uncontrolled rise in yields and simultaneously support equity markets.
In the subsequent press conference, then-Fed President Kevin Warsh impressed with his confident demeanour. He made it clear that, given persistent price pressure, the central bank had to prioritise price stability. He cited geopolitical risks and the energy price shock that followed the escalation of the Iran conflict as central inflation drivers, without directly criticising the then-US government for its involvement. At the same time, Warsh highlighted the growing concern among many Americans about the rising cost of living. He pointed out that approximately half of the population had hardly any assets in the form of property or equities and therefore relied particularly on a stable labour market and low inflation. Warsh thus addressed the issue of the affordability of daily life, which had become a pressing problem for broad sections of the population.
Challenges of Affordability
The political sensitivity of this point lies in the fact that the government at that time hardly addressed this problem consistently. Instead, Trump's tariff and migration policies, as well as significantly increased oil prices due to the war, had further exacerbated inflationary pressure. Warsh thus adopted an economically sober and comprehensible, yet politically uncomfortable, position. The actual winner of the interest rate decision is therefore not only the Fed's monetary policy independence, but Kevin Warsh himself in particular. He presented himself as the president of a central bank that withstands political pressure, clearly identifies economic realities, and keeps in mind the interests of those most affected by the rising cost of living. This combination, according to Carsten Mumm, Chief Economist at private bank DONNER & REUSCHEL, could explain why Warsh would also have a good chance as US President.
