What Is a Rate Cut? Why Do Central Banks Lower Interest Rates?

What is interest rate reduction?

“Interest rate cut” refers to “lowering the interest rate,” which means that the Central Bank lowers the benchmark interest rate to reduce the loan and deposit rates across the entire financial system. Taking the United States as an example, the Federal Reserve guides the market interest rate level down by lowering the federal funds rate target range; China achieves the same effect by adjusting the LPR (Loan Prime Rate) or reverse repurchase rate.

From a macro perspective, interest rate cuts reflect the easing of monetary policy, aimed at stimulating economic growth.

The Purpose and Logic of Interest Rate Cuts

The Central Bank will consider lowering the Interest Rate under the following circumstances:

1. Economic growth slowdown: For example, a decline in GDP growth or weak consumption. The government hopes to stimulate consumption and investment by lowering loan costs.
2. Rising unemployment rate: hoping to stimulate business expansion and create jobs through interest rate cuts.
3. Deflation risk: Continuous price declines may create a vicious cycle, and lowering the Intrerest Rate can help raise market inflation expectations.

In general, lowering interest rates is about “fueling” the market, making money cheaper and circulation smoother.

How to operate on interest rate cuts? What did the Central Bank do?

The Central Bank usually implements interest rate cuts in the following ways:

• Lowering policy interest rates: such as the federal funds target rate, rediscount rate, SLF (Standing Lending Facility), etc.
• Open market operations: purchasing government bonds or conducting reverse repos to release base currency.
• Forward Guidance: For example, the Federal Reserve will guide market expectations for future interest rate cuts through statements.

When the Central Bank interest rate decreases, the financing costs of commercial banks also decline, which in turn affects loan rates and mortgage rates, ultimately influencing the behavior of businesses and consumers.

What are the pros and cons of lowering interest rates?

Intrerest Rate:

• Reduce corporate financing costs and encourage expansion and investment.
• Lower personal loan interest rates to stimulate home buying and consumption.
• Promote the rise of asset prices, especially in the stock and bond markets.
• Enhance market confidence to avoid an economic recession.

Disadvantages:

• The profit margins of banks are constrained, affecting the stability of financial institutions.
• Deposit holders’ earnings have decreased, and the attractiveness of long-term fixed deposits has declined.
• If monetary easing is excessive, it may trigger asset bubbles.
• The room for interest rate cuts is limited; if the economy remains weak, the effectiveness of policies will diminish.

Latest news: The Federal Reserve signals interest rate cuts.

The minutes from the June 2025 FOMC (Federal Open Market Committee) meeting indicate that a majority of officials support one or more rate cuts within the year. Although current U.S. inflation has not fully returned to the target range of 2%, signals such as a cooling job market and weak consumption are prompting the market to widely expect that the Federal Reserve will initiate rate cuts in September or December.

Predictions from institutions such as Goldman Sachs, Citigroup, and Morgan Stanley vary slightly, but it is generally expected that the Federal Reserve will lower interest rates at least once in the second half of 2025.

U.S. Treasury yields have been declining recently, and gold prices have risen to $3330 per ounce, further confirming that the market is “betting” on the onset of a rate cut cycle.

How should beginners view interest rate cuts? Investment advice整理

• Regularly pay attention to Central Bank interest rate meetings: especially the policy statements of the Federal Reserve, European Central Bank, and People’s Bank of China.
• Understanding Signals: Bond Market Leads, Gold Strengthens, Stock Market Reacts Early.
• Asset allocation adjustment: The period of interest rate cuts is suitable for increasing the proportion of bonds and growth stocks, while reducing excessive reliance on savings-type assets.