For the second time in three months, the US Federal Reserve hiked its benchmark interest rate a quarter point amid surging confidence that the American economy is poised for more robust growth. While the Federal Open Market Committee’s (FOMC’s) decision to raise the target range for the federal funds rate by 0.25 percentage point from 0.75 per cent to 1 per cent was broadly on expected lines, the big takeaway for the markets was the Fed’s signal of that there would be no pick-up in the pace of future rate hikes. Projecting a “gradual” approach on upcoming hikes, the Fed has continued with its projection of two more increases this year, signalling more vigilance as inflation approaches its target.
Responding to the move, in early trade on Thursday, the rupee hit a one-year high of 65.4 against the dollar. With a rally of over three per cent during the early part of 2017, the rupee is the sixth best performing currency against the dollar among key world currencies. The strengthening of the rupee has mostly been driven by the foreign institutional investment (FII) fund flow into the equity markets in the expectation of accelerated pace of reforms after the Bharatiya Janata Party’s (BJP’s) sweep in Assembly polls in Uttar Pradesh.
The impact on India of the US rate hike, according to an SBI Ecowrap analysis, will be muted partly because the results of the UP elections have “altered view of country risk for India beyond 2019”. Though the currency can appreciate in the short term, the rupee is expected to settle at Rs 66.5-67.5 per dollar at the end of 2017. However, it said that this view is subjected to position taken by other central banks in response to the US Fed rate hike. The fall-out of the present rate hike is already divergent with the Bank of Japan (BoJ) maintaining a status quo and People’s Bank of China indicating a tightening stance.
Global credit rating agency Moody’s Investors Service had echoed the view on the BJP’s assembly poll wins as a “credit positive” for the Indian sovereign, coming on the back of the negative economic hit from demonetisation. While Moody’s maintains its lowest investment grade rating of Baa3 for India with a positive outlook, it stated that the state elections have yielded substantial gains to the government and reflects strong popular support for Prime Minister Narendra Modi’s national policy agenda.
According to the FOMC projections made on Wednesday, the federal funds rate would be 1.4 per cent at the end of this year, 2.1 per cent at the end of next year, and three per cent at the end of 2019, in line with its estimated longer-run value. The SBI Ecowrap research noted that “linear, homogeneous narrative on inflation and unemployment rate” continues to dominate the Fed’s decision. “If the economy has reached a full employment in March 2017, it is at the back of a falling labour force participation rate which is one of the factors why unemployment rate has fallen.
The present Fed rate hike also closely coincides with the expiry of US Treasury’s debt limit next week, indicating that the strain between monetary and fiscal arms of the policy will now surface.
The BoJ kept monetary policy steady on Thursday in the wake of the Fed’s second interest rate hike in three months, underscoring the diverging policy paths of major global central banks. Economists had expected no change in the BoJ’s policy settings as rising global protectionist sentiment and an expected series of US rate hikes overshadow budding signs of recovery in the trade-reliant Japanese economy.