Opinion Express View: Navigating an economically uncertain environment safely

Events of the last few weeks — the collapse of three banks in the US and one in Europe — had raised questions over whether central banks would continue to raise interest rates in their fight against inflation or attach primacy to concerns over financial stability. Last week, just days before UBS agreed to buy out its tottering, troubled rival Credit Suisse, the European Central Bank had chosen to raise interest rates by 50 basis points. ECB President Christine Lagarde was, however, quick to differentiate between the tools available to the central bank for inflation management and financial stability. On Wednesday, despite concerns over stress in the financial system, the US Federal Reserve followed suit, raising its policy rate by 25 basis points. The focus remains on bringing down inflation.

Alongside, the Fed sought to allay fears over stress in the financial system. It emphasised that the US banking system was “sound and resilient”. Fed Chairman Jerome Powell said that “deposit flows in the banking system have stabilised over the last week.” This is in line with comments by US Treasury Secretary Janet Yellen. However, this does not mean that events of the last few weeks have not been factored in by committee members. The policy statement notes that the developments in the financial system are “likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring and inflation.” While there is uncertainty over the extent of these effects, as Powell has said, what is happening could “substitute for rate hikes”. In fact, “some” committee members have factored in the financial conditions in their economic projections. The forecasts accompanying the Fed meeting show that expectations of the terminal rate — the rate at which policy tightening will be paused — centre at 5.1 per cent.

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Central banks now face a difficult balancing act. The next meeting of the RBI’s monetary policy committee is scheduled for the first week of April. While core inflation continues to remain a matter of concern, there is a view that considering the long lags in monetary policy transmission, the MPC should ideally pause at this juncture and wait for the full impact of the rate hikes to be felt across the economy. In an increasingly uncertain economic environment, the central bank must be guided by the objective of maintaining macroeconomic stability.