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US Fed signals easing of interest rate hikes: Will RBI follow suit?

It is widely expected that the US Federal Reserve will hike the interest rate by 50 basis points in the December policy, compared to an earlier projection of 75 basis points.

US Fed building and RBI.The Reserve Bank of India’s Monetary Policy Committee (MPC), which is meeting on December 5-7 ahead of the US Fed meet, may also hike policy interest rate, but by a smaller quantum. (Photo via Reuters, left, Express file, right)

US Federal Reserve Chairman Jerome Powell recently hinted that the central bank will moderate the pace of monetary policy tightening in the next policy meeting scheduled on December 13-14, leading to a rally in the stock markets. The Reserve Bank of India’s Monetary Policy Committee (MPC), which is meeting on December 5-7 ahead of the US Fed meet, may also hike policy interest rate, but by a smaller quantum.

What is the US Federal Reserve likely to do?

It is widely expected that the US Federal Reserve will hike interest rates by 50 basis points in the December policy, compared to an earlier projection of 75 basis points. This slowdown in interest rate hike is likely after the US Consumer Price Index eased to 7.7 per cent in October from 8.2 per cent in September, many analysts believe. The Federal Open Market Committee (FOMC) has kept a 2 per cent target for inflation over the long run.

Since March this year, the US Fed has raised interest rates by 3.75 percentage points. It raised rates by 75 basis points in each of the last four meetings held between May and November, 2022.

In a recent speech, Powell said monetary policy affects the economy and inflation with uncertain lags, and the full effects of our rapid tightening so far are yet to be felt. “Thus, it makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting,” he had said on November 30.

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Joining Fed President, Fed Governor Michelle Bowman, on Thursday, also hinted at a slower pace of rate hike in the coming months

What will be the RBI’s move?

Economists feel that the RBI in the upcoming monetary policy may hike the repo rate by 25-35 basis points, as retail inflation eased to a three-month low of 6.77 per cent in October from 7.41 per cent in September.

In a recent research report, Nomura said while Q2 FY23 GDP growth has come in line with the RBI’s projection of 6.3 per cent, still sticky core inflation should nudge the RBI towards further hikes, but at a slower pace. “Our base case envisages a downshift to a 35 bps hike at the December 7 meeting, followed by a final 25 bps in the February meeting, although the latter is a close call,” it said.

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Between May and September, the RBI has raised rates by 190 basis points to 5.90 per cent. In each of the last three policies, the RBI raised the repo rate by 50 bps to check inflation.

Fed decision impact

Analysts say the US Federal Reserve’s decision to increase interest rates does have an impact on emerging market economies, including India, in terms of capital flows. Currently, the interest rate in the US is at 3.9 per cent and that in India is at 5.9 per cent. Therefore, the interest rate differential between the US and India is 2 per cent. In case the US Fed raises the rate by 50 basis points and the RBI keeps the rate unchanged, the interest rate differential will reduce to 1.5 per cent, which makes India a less attractive destination for foreign investors.

“The US is the exporter of capital to the world as a large amount of funds flows from there to emerging market economies. For India to attract flows and build foreign exchange reserves, an increase in interest rate is necessary at this point,” said a foreign exchange expert.

First published on: 02-12-2022 at 18:33 IST
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