The Federal Reserve signaled greater doubt over how much it would continue to cut interest rates after agreeing to a reduction on Wednesday that Chair Jerome Powell conceded had been a close call.

Stocks went into a nosedive, with the major indexes all logging their worst day in months.

The declines accelerated throughout the afternoon as investors digested central-bank forecasts and comments from Powell that spurred concerns that rates might not go down again soon. That was a notable shift after the Fed initiated rate reductions with a larger than usual half-point cut in September in the midst of expectations that a steady sequence of cuts could follow.

“Today was a closer call, but we decided it was the right call,” Powell said at a news conference after the meeting. He later added, “From here, it’s a new phase, and we’re going to be cautious about further cuts.”

The Dow Jones Industrial Average lost more than 1,100 points, or 2.6%. That marked its 10th loss in a row—its worst losing streak in 50 years. The S&P 500 lost nearly 3%, and the Nasdaq Composite lost 3.6%. The U.S. dollar jumped to its highest value against a basket of other currencies in more than two years.

Investors weren’t prepared for the magnitude of the shift that officials had been hinting at before Wednesday’s meeting, said Diane Swonk , chief economist at KPMG. “The market just assumed they would slow down to cuts at every other meeting, and that was the wrong assumption,” she said.

New projections released Wednesday show Fed officials expect inflation to be stickier next year than previously anticipated, possibly because of policy changes by President-elect Donald Trump . The projections show officials expect to make fewer rate reductions, with most penciling in two cuts for 2025, down from four at their meeting in September.

Officials have been trying to pull off a balancing act. They want to prevent the aggressive rate increases of the past two years from unnecessarily slowing down economic activity now that price and wage growth has cooled, but they don’t want to undo recent progress on inflation.

“They’re in a tough spot where it feels like there is no right answer. It is a difficult time to be making policy,” said Michael de Pass, global head of rates trading at Citadel Securities. “There is an inconsistency” in cutting rates while anticipating firmer inflation “that is difficult to square,” he said.

The magnitude of the revision to the inflation forecast was broad-based among the 19 officials who participate in policy meetings and incredible given how little officials changed their forecasts for the labor market and growth, said Omair Sharif, founder of the research firm Inflation Insights.

“This wholesale change in their views are clearly tied to uncertainty and risks around as-yet-enacted tariff and immigration policies and have far less to do with changes to the economic landscape,” he said. Wednesday’s forecasts were the first that Fed officials released since last month’s presidential election.

Inflation has declined notably since the middle of 2023, but the slowdown in price growth has been uneven at times, including in the past two months. Based on the Fed’s preferred inflation gauge, so-called core prices that exclude volatile food and energy items rose 2.8% for the year ended in October. Officials expect those prices to rise by 2.5% next year, up from their expectations just a few months ago for 2.2%.

Powell said recent data, and not just potential policy shifts, warranted a change in the inflation forecast. The labor market has also been a little sturdier than officials thought it would be when they started cutting in September.

The latest cut, approved by 11 of 12 Fed voters, will lower the central bank’s benchmark federal-funds rate to a range between 4.25% and 4.5%, a two-year low. It marks the third reduction in a row and leaves the rate a full percentage point below where it stood before September.

Trump has promised to impose tariffs and deport unauthorized immigrants upon his inauguration next month. Steps that boost domestic prices by raising the cost of imports or that increase wage pressures in certain industries through tighter immigration controls could muddy the inflation outlook .

Economists at Goldman Sachs, for example, expect tariffs could boost core inflation by 0.3 percentage point over the next year. While most of that effect would fade in 2026, it could cause discomfort inside the central bank because that would lead inflation to run meaningfully above its 2% target for five years.

Powell repeated his view that it was possible but too soon to tell if the current situation would differ from an episode in 2018-19, when Trump launched a trade war with China after imposing tariffs on steel and aluminum more broadly.

Back then, inflation was low, and businesses had little experience pushing cost increases along to customers. The inflation shock of 2021-22 means that the psychology regarding inflation might have changed in ways that make companies and workers more comfortable passing along higher prices and demanding higher wages, respectively.

Not every Fed official who participates in the meeting has a vote on the rate-setting committee. In their rate projections, a total of four officials indicated that Wednesday’s cut wasn’t necessary under “appropriate monetary policy,” a sign others might also have preferred holding rates steady.

In the run-up to this week’s meeting, several officials had suggested they had less conviction on the need to reduce rates steadily. Investors in interest-rate futures markets, which had already anticipated the Fed would stand pat at its next meeting in late January, now see officials holding rates steady for at least their next two meetings.

Cleveland Fed President Beth Hammack , who joined the central-bank system in August, dissented against the decision to lower rates. She favored holding rates steady.

Powell said officials were ready to slow down cuts because of uncertainty over how restrictive their policy stance would be after having made a full percentage point in cuts.

Before the pandemic, many Fed officials concluded that the so-called neutral rate of interest that neither slows nor spurs growth had fallen below 3%. Because the economy proved more resilient than expected to rapid interest-rate increases that Fed officials made in 2022 and 2023, some officials are concluding that the neutral rate has gone up. If it has, then the Fed is closer to its ultimate destination.

Labor markets remain in a delicate equilibrium. Hiring rates are low, but so are layoffs. Income growth has supported strong consumption, and Fed officials have been looking for signs that job growth is settling out at a pace that can hold the unemployment rate steady.

Rate cuts have provided some immediate relief to consumers with credit-card balances and small businesses with variable-rate debt. But long-term borrowing costs, on everything from mortgages and auto loans to corporate debt, have risen in recent months as investors have reduced their bets on aggressive rate cuts over the coming year.

Write to Nick Timiraos at Nick.Timiraos@wsj.com