Fed & RBI: Shared challenges, separate turfs

For Fed, RBI, it’s same battle, different fields
For Fed, RBI, it’s same battle, different fields


The Fed’s decision to hold rates is not surprising as pricing pressures in the US have eased significantly from the highs.

The US Federal Reserve (Fed) is back to a pause again. Following a status quo in June, and a 25 basis point (bps) rate hike in July, the Fed held its policy rate steady in September, in line with market expectations. With this, after a spate of rate hikes since March 2022, the benchmark Fed funds rate now stands at 5.25-5.50%, the highest since 2001.

The Fed’s decision to hold rates is not surprising as pricing pressures in the US have eased significantly from the highs. For instance, headline consumer price index (CPI) inflation has come off record highs, core inflation (CPI excluding food and energy prices) was at a multi-month low in August, and long-term household inflation expectations remain contained.

Graphic: Mint
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Graphic: Mint

It helps that the central bank believes the current monetary policy stance will continue to weigh on economic activities, hiring, and inflation.

However, the policy guidance is more hawkish than expected. First, the Fed has reaffirmed that further tightening cannot be ruled out.

Second, its economic projections pencil in that the consequent rate easing cycle next year is likely to be shallow i.e. lesser quantum of rate cuts.

The September policy statement acknowledges that economic activity in the US has been expanding at a “solid pace" now versus “moderate pace" of expansion mentioned in the July policy brief. This shift in growth momentum also reflects in the Fed’s economic projections. Fed members now expect real gross domestic product (GDP) growth at 2.1% year-on-year in 2023, far higher than 1% expected in June.

That said, the recent inflation dynamics warrant some vigil. After being on a downtrend since June 2022, CPI inflation in US has inched higher in July and August, besides remaining above the Fed’s medium-term target of 2%. While there has been a sustained easing in core inflation, solid economic momentum and tight labour markets continue to exert upward pressure. Here, the recent uptrend in global crude oil prices is particularly worrying.

Moreover, there are upside risks to oil prices amid the Opec supply cuts, dwindling oil inventories and strong demand.

Given this, Fed officials have marginally revised the CPI projection upward for 2023. The potential upside to the inflation trajectory would keep the window for another rate hike open this year.

Of course, the moot question is whether the Fed will achieve its inflation goals and simultaneously avoid a hard landing. ING’s economists point out in a note on 20 September: “Officials are firmly of the view they can generate a soft landing/no recession while guiding inflation towards the 2% target over time. This is a bold call given all the uncertainties out there and makes it appear more likely that the Fed will indeed carry through with another hike even though we don’t think it is necessary."

Looking beyond this year, the sharp reduction in the expected quantum of rate cuts for next year is intriguing.

Fed officials now project just 50 bps of rate cuts in 2024, down from 100 bps expected in July, strengthening the case for elevated interest rates for longer.

Meanwhile, back home, the Reserve Bank of India (RBI) is faced with a similar macro mix, though with its own set of challenges. While domestic economic momentum remains well supported, retail inflation has exceeded the upper limit of RBI’s tolerance band of 2-6% in the past two months.

This along with a slew of upside risks to inflation emanating from the continuing effect of El Nino, higher oil prices and festival spending would mean a longer pause in policy rates.

Thus, akin to the US, rates are likely to stay elevated for longer in India, too.

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