Rate cut hopes pushed back as inflation fears resurface

While Fed’s rate cut exercise may have been pushed back, Sweden takes the lead in cutting policy rate by 25 bps. Meanwhile, the RBI’s rate setting committee will meet after the general election results and it will be an interesting event to watch out for

Hopes of the June interest rate cut by the US Federal Reserve has received a setback. It is quite certain that the largest central bank is in no hurry to loosen its iron grip on the fight against inflation. The possibility of three rate cuts this year also looks far-fetched, now. So, what has suddenly unsettled the applecart?

Fed’s target of 2 per cent inflation will have to wait longer to get there as the latter has shown stubbornness. The situation remains sticky with no clear indication of the timing and the course of action.

At 3.5 per cent, the March consumer price index (CPI) in the US moved faster than what was estimated. It was 30 bps higher than February inflation at 3.2 per cent. The inflation numbers shot up on higher food, shelter and energy prices.

While the Federal Reserve’s Chair, Jerome Powell has been underlining that there would be no further rate hikes, Fed Governor Michelle Bowman, one of the most hawkish voices in the US central bank has said that she would not mind favouring a rate hike, should the progress on inflation stall or reverse.

While the Fed has been able to bring down inflation from a near 10 per cent level to levels around 3 per cent now, the progress has been much slower than it was anticipated. A fatigue factor is now creeping in on the progress of inflation mitigation.

The Fed’s policy rates are hovering around more than two-decade high levels of 5.25 per cent to 5.5 per cent. The interest rate hike which started from near zero levels since March 2022 with back-to-back 70 bps increase. It was followed by 50-25 bps cuts. In the exercise Fed raised federal funds rate 11 times before putting a pause in July last year.        

Now a 75-bps cut in 2024 looks like a distant dream with the likelihood of cuts not happening at all this year in the worst-case scenario. A section of economist’ fraternity sees a single rate cut of 0.25 percentage points.

The progress on inflation control has been slower in the first three months with prices rising faster than expected. Seeing this, Powell has reiterated that it would take longer to reach the target.

The strength in the US economy has been one of the hallmarks of this period. Despite naysayers expressing concerns and predicting slowdown, the growth has been steady and employment numbers remaining robust. Many other economic indicators have also remained strong.

Fed’s own assertions have been that it is ready to compromise on growth to ensure price stability and meet 2 per cent target.

While Biden administration has managed the economy relatively well despite elevated levels of rates and withdrawal of liquidity by Fed, it can be an election issue this time as cost of living remains high. 

To Biden’s credit, the wages have been rising faster than the inflation but according to media reports the current prices are 20 per cent higher than what they were when Biden took charge as president.

A funny thing and the human psychology is that people tend to see what they are paying for day-to-day things in isolation and notwithstanding fatter paycheques that they get.

By virtue of being world’s largest central bank, Fed is emulated by central banks in most developed and emerging economies.

Our own Reserve Bank of India (RBI) was ahead of the curve and was first among major Central Banks to have made a pause on rate hikes.

Earlier this week, Swedish central bank made a departure by becoming the first bank to reduce rate by 25 bps. The policy rate is now 3.75 per cent in Sweden, down from 4 per cent earlier. It has also hinted at two more cuts.

Will others follow? Well, it is a difficult question as geopolitically, the world is quite fragile now. The war between Russia and Ukraine is still ongoing though out of headlines. The Israel-Hamas appears to be relatively low profile now but we do not know if things are simmering beneath. 

We have seen that the Middle East tensions have kept crude oil prices on the boil and we war escalates it would be a double whammy as not just the prices will go up but dollar will strengthened. This could have a catastrophic impact on large oil importers such as India.

Experts are not ruling out possibility of oil prices breaching the USD 100 per BBL mark.

This is what is preventing a decisive stance on the timing of rate cuts.

Indian context

Lending rates in India are linked to Marginal Cost of funds based Lending Rate (MCLR) which is linked to repo rate – the rate at which commercial banks borrow money from the RBI. While credit growth for banks have been robust, people have been paying more on their EMIs for more than two years now.

Notwithstanding this the appetite for loans has been good with retail loan books growing for most banks.

Inflation has increased the cost of living across the world and which has been responsible for lower savings by most households.

Any negative disruption akin to Covid-19 or a natural disaster could break the back of people, especially those who have been pulled out of poverty back into it. Which is why it is important to save more or generate income at a faster pace.

The RBI’s monetary policy committee (MPC) will meet in June to decide policy rates and give its commentary on interest rates, Indian economy and inflation outlook.

It will be an important event given that the outcome of the ongoing general elections will be known by then. It will be interesting to see if the incumbent government continues or a new regime takes over.    India’s macro indicators like the GDP growth, tax collections etc have been strong and a rate cut and controlled inflation could fire the right engines.     

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