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The options for RBI after Fed hike

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  • The US Federal Reserve on Wednesday raised its benchmark interest rate by another 75 basis points to cool scorching inflation. This was its second 75 bps hike in a row, and the fourth increase this year. Mint looks at what this rate hike means and its impact on Indian economy.

What is the rationale for the US Fed action?

The US Fed raised the official interest rate by 0.75% to cool the economy and bring down inflation. It also raised the target range for the federal funds rate to 3%-3.5%. The central bank also affirmed its commitment to continue reducing its holdings of treasury securities, agency debt, and agency mortgage-backed securities for reducing the size of the Fed’s balance sheet. The Fed chair also said that some parts of the economy like spending and production have weakened. However, he noted that “job gains have been robust in recent months, and the unemployment rate has remained low."

What did the Fed chief say at the meeting?

Federal Reserve chairman Jerome Powell noted that another unusually large interest rate rise might be needed in September but would depend on upcoming economic data. He said it was too soon to say whether the Fed would reduce the size of its rate increases at its September meeting. But he said that at some stage, it would be appropriate to slow the pace of rate hikes to assess their impact. He reiterated the central bank’s commitment to bringing down inflation to 2% over the long run from the current 9.1%. The chairman also said the slowdown in economic growth during the second quarter had been notable.

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Why is US Fed going slow on forward guidance?

Chairman Powell said that the Fed is not planning to offer any more forward guidance this year, after admitting that the Fed has no idea how things will go in response to Fed policy. Powell said that moving forward, “we think it’s time to just go to a meeting-by-meeting basis, and not provide the kind of clear guidance that we did on the way to neutral."

What is the impact on Indian markets?

The hike was on expected lines and largely factored in by the markets. The tone of Fed’s chairman was less hawkish compared to previous statements. Rupee closed at 79.76 on Thursday versus Wednesday’s closing of 79.90. Ten-year G-sec closed at 7.33% versus Wednesday’s closing of 7.34%. The hike, however, could have an impact on the rupee going forward. When the Fed raises its rates, the interest difference between the US and India narrows, resulting in outflow of foreign funds and a weaker rupee.

What does it mean for next RBI policy meet?

With no surprise from Fed, market participants expect RBI to hike the repo rate by 35-50 basis points. Since the start of FY23, RBI has effectively raised rates by 90 bps. While it need not rate hikes aggressively as inflation is stabilizing, RBI will have to ensure that there exists an interest rate differential between India and US to attract dollars. RBI is likely to keep inflation forecast at 6.7% and growth forecast at 7.2% for FY23. RBI Governor Shaktikanta Das recently said that headline inflation appears to have peaked.

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