The U.S. Federal Reserve cut its key interest rate Wednesday by a quarter-point — its third cut this year — but also signalled that it expects to reduce rates next year more slowly than previously thought, with inflation still well above the central bank's two per cent target.

The Fed's 19 policymakers projected that they will cut their benchmark rate by a quarter-point just twice in 2025, down from their September estimate of four rate cuts. Their new projections suggest that consumers may not enjoy much lower rates next year for mortgages, auto loans, credit cards and other forms of borrowing.

Fed officials have underscored that they are slowing their rate reductions as their benchmark rate nears a level that policymakers refer to as "neutral" — the level that is thought to neither spur nor hinder the economy.

Wednesday's projections suggest that the policymakers may think they are not very far from that level. Their benchmark rate stands at 4.3 per cent after Wednesday's move, which followed a steep half-point reduction in September and a quarter-point cut last month.

"I think that a slower pace of [rate] cuts really reflects both the higher inflation readings we've had this year and the expectations that inflation will be higher" in 2025, chair Jerome Powell said at a news conference.

"We're closer to the neutral rate, which is another reason to be cautious about further moves.

"Nonetheless," Powell said, "we see ourselves as still on track to cut."

Loonie slides in response to the cut

The Canadian loonie slid further against the U.S. dollar — which continues to outperform other currencies — in reaction to the cut on Wednesday afternoon.

"Jerome Powell was talking about a U.S. economy that is clearly outperforming not just domestic expectations, but also the rest of the world," said Karl Schamotta, chief market strategist at Corpay, a payment management company Toronto.

"That means U.S. interest rates are high, and that's making U.S. markets the best place in the world to park money."

Several other factors have driven the loonie's decline over the last few months and years, including the end of a "supercycle" that saw high demand for Canadian energy, as well as high household debt slowing consumer spending and Trump's threat of a 25 per cent tariff on Canadian goods.

With that, "you have essentially a deadly cocktail for the Canadian dollar," Schamotta told CBC News. And the loonie could sink "at least a couple of cents lower" if Trump goes through with his threat.

That would hit the exports sector hard. Consumer sentiment in Canada would sink, and businesses would pull further back on investment, Schamotta said.

"All of that would mean that Canada would very likely topple into a recession."

Yet Canadian exporters are hurt when the loonie performs too high against the U.S. dollar, Schamotta said. A lower correction could mean that some of those exports "are going to be put in a better position."

"They're going to be able to sell cheaper exports to the world, and they're going to be able to grow," he said. "So this is a bit of a rebalancing process."

High inflation persists, pace of hiring cools

This year's Fed rate reductions have marked a reversal after more than two years of high rates, which largely helped tame inflation but also made borrowing painfully expensive for American consumers.

But now, the Fed is facing a variety of challenges as it seeks to complete a "soft landing" for the economy, whereby high rates manage to curb inflation without causing a recession. Chief among them is that inflation remains stubborn: According to the Fed's preferred gauge, annual "core" inflation, which excludes the most volatile categories, was 2.8 per cent in October. That is still persistently above the central bank's two per cent target.

At the same time, the economy is growing briskly, which suggests that higher rates haven't restrained it much. As a result, some economists — and some Fed officials — have argued that borrowing rates shouldn't be reduced much more for fear of overheating the economy and reigniting inflation.

On the other hand, the pace of hiring has cooled significantly since 2024 began, a potential worry because one of the Fed's mandates is to achieve maximum employment.

"We don't think we need further cooling in the labour market to get inflation below two per cent," Powell said at his news conference.

While still low at 4.2 per cent, the unemployment rate has risen nearly a full percentage point in the past two years. Concern over rising unemployment contributed to the Fed's decision in September to cut its key rate by a larger-than-usual half-point.

Trump's tariff threats heighten uncertainty

On top of that, U.S. president-elect Donald Trump has proposed a range of tax cuts and a scaling-back of regulations that collectively could stimulate growth. And his threatened tariffs and mass deportations could accelerate inflation.

Powell and other Fed officials have said they can't assess how Trump's policies might affect the economy or their own rate decisions until more details are made available. Until then, the outcome of the presidential election has mostly heightened economic uncertainty.

That was underscored by the quarterly economic projections the Fed issued Wednesday.

The policymakers now expect overall inflation, as measured by their preferred gauge, to rise slightly from 2.3 per cent now to 2.5 per cent by the end of 2025. 

The officials also expect the unemployment rate to inch up by the end of next year, from 4.2 per cent now to a still-low 4.3 per cent.