RBI vs US Fed: Which central bank will cut interest rates first? Here’s a 5-point analysis

RBI vs US Fed: The Reserve Bank of India (RBI) unveiled its third monetary policy committee (MPC) meeting for 2024 on August 8, keeping the benchmark rate at 6.50 per cent and policy stance unchanged for the ninth straight meeting, saying it could not afford to look through persisting high food inflation.

RBI Governor Shaktikanta Das-led rate-setting panel revealed the monetary policy decision after a two-day review meeting that began on Tuesday. The decision comes amid rising food prices and ongoing geopolitical headwinds threatening demand and supply to India's commodities basket.

Also Read: RBI monetary policy: Status quo on repo rate for 9th consecutive time - 5 key highlights from RBI MPC outcome

On the other hand, the US Federal Reserve announced its interest rate decision on July 31 after a two-day Federal Open Market Committee (FOMC) meeting, leaving the benchmark interest rates unchanged at 5.25 per cent - 5.50 per cent for the eighth straight meeting, in line with Wall Street estimates.

Fed chair Jerome Powell-led rate-setting panel ended its fifth policy-setting meeting for 2024 on July 31 and unanimously voted to keep the policy rate at the 23-year high. The US central bank has maintained borrowing rates steady for 12 straight months to bring down inflation in the world's largest economy.

Powell set the stage for the central bank's first rate cut in four years, citing greater progress toward lower inflation and a cooler job market that no longer threatens to overheat the economy. Powell said if US inflation continues to fall, “a reduction in our policy rate could be on the table" when the Fed next meets in September.

On RBI's stance, Radhika Rao, Executive Director and Senior Economist at DBS Bank said, ‘’Policy guidance reinforced that domestic considerations will be prioritised despite a sharp buildup in rate-cut pricing for the US Fed.''

Also Read: RBI reveals gross NPA of banks hit 12-year low of 2.8%, credit growth to improve; 5 key highlights of June report

‘’The RBI MPC retained its cautious tone on inflation amid an anticipated passthrough from perishables price pressures and tariff adjustments. With domestic demand conditions calling for a focus on inflation, we expect the policy rate to stay on hold for the rest of the year,'' added Rao.

In the current economic and market scenario, several global central banks have started cutting interest rates, with the US Fed preparing to reduce its policy in September, depending on a consistently low inflation rate. Let's take a look at the five parameters which will determine the rate-cutting cycle for RBI and US Fed:

RBI vs US Fed: Which central bank will cut interest rates first?

1.Inflation

India's retail inflation based on the consumer price index (CPI) rose to 5.08 per cent year-on-year (YoY) in June after dropping to a 12-month low of 4.75 per cent in May. The rise in June was due to higher food inflation, which accounts for nearly 40 per cent of the consumer price basket. Food inflation based on the consumer food price index (CFPI) rose 9.36 per cent YoY in June, compared to an 8.69 per cent rise in May and 8.70 per cent in April.

US inflation cooled for the third straight month and rose less than expected in June 2024, giving a major boost to Wall Street bets for definite interest rate cuts by the US Federal Reserve. The favourable inflation print of the world's largest economy resulted from a long-awaited slowdown in housing prices, signalling that the worst price rise in nearly four decades is gradually fading away.

The US consumer price index (CPI) — which excludes food and energy costs — slid 0.1 per cent in June after being unchanged in May. This was the smallest advance in three years -- the weakest monthly reading since May 2020, when the COVID-19 pandemic paralyzed the US economy.

Also Read: US Fed holds key rates elevated at two-decade high, Powell nods to possible September cut; 5 major takeaways
 

2.GDP Growth

India's gross domestic product (GDP) for the January-March quarter of fiscal 2023-24 (Q4FY24) came in at 7.8 per cent, driven by strong growth in the manufacturing sector. The Indian economy beat D-Street estimates and grew by 8.2 per cent for the full year (FY24). Economists expect the momentum to remain strong this year.

The United States of America's real GDP increased at a rate of 2.8 per cent for the April to June quarter of the financial year 2024-25. The increase in the real GDP is reflected in the increase in consumer spending on goods and services with a key focus on health care, housing and utilities, and recreation services, according to the government release.

3.Unemployment

India's unemployment rate rose to an eight-month high of 9.2 per cent in June 2024, up from seven per cent in the previous month and 8.5 per cent in June 2023, according to data from the Centre for Monitoring Indian Economy (CMIE). The unemployment rate measures the number of people who are unemployed and actively looking for a job among those in the labour force.

Also Read: US inflation cools for third straight month at 0.1% in June; Wall Street lifts Fed rate cut bets for September

The US unemployment rate rose to 4.3 per cent in July and hiring slowed, adding signs of a broader downturn in the US economy. The Bureau of Labor Statistics reported that the US added 114,000 jobs, down from 206,000 in June. The data fueled recession worries in the world's largest economy, and economists said the US Federal Reserve has waited too long to cut interest rates to lower inflation. 

Also, the number of Americans filing applications for unemployment benefits fell more than expected last week. The US Labor Department reported that the initial claims for state unemployment benefits fell 17,000 to a seasonally adjusted 233,000 for the week ended August 3, the largest drop in nearly 11 months. 

4.Liquidity

According to the latest RBI data, surplus liquidity in the banking system stood at ₹2.78 trillion. ‘’Banks are turning to short-term non-retail deposits and other liability instruments to meet credit demand and other funding requirements, ‘’ said the RBI Governor, adding, “This may potentially expose the banking system to structural liquidity issues.''

On the other hand, the US Fed said, ‘’The Committee will continue reducing its holdings of Treasury securities, agency debt and agency mortgage‑backed securities.'' The Fed had announced it would scale back the pace at which it is shrinking its balance sheet starting on June 1, allowing $25 billion in Treasury bonds to run off each month compared to the current $60 billion.

Also Read: Oil rises for third straight session from record lows on MidEast tensions, positive US job data; Brent at $79/bbl

5.Stance

The RBI's MPC panel, whose four-year term ends in October, also opted to retain its relatively hawkish policy stance of “withdrawal of accommodation.” The MPC “has to remain vigilant to prevent spillovers or second-round effects from persistent food inflation and preserve the gains made so far in monetary policy credibility,” said RBI Governor Shaktikanta Das earlier today.

In its statement, the US Fed admitted there has been some further progress toward the two per cent inflation objective. This marks a slight change in tone from its June statement when it noted only that "modest further progress" had been made. “We’re getting closer to the point at which it’ll be appropriate to reduce our policy rate,” Powell said, “but we’re not quite at that point.”

Also Read: RBI’s new liquidity coverage guidelines for banks could slow credit growth

D-Street experts on rate cuts

Analysts say that statements from central banks have gained heightened importance following Japan's interest rate hike, with significant attention on the Federal Reserve's potential acceleration of rate cuts in the United States. 

Sunil Damania, Chief Investment Officer, MojoPMS, said, ‘’Considering the global context, along with the higher base effect and favourable monsoon conditions, it would have been prudent for the Reserve Bank of India (RBI) to cut interest rates in the latest monetary policy.''

‘’However, the RBI opted to maintain the status quo to safeguard the rupee, which has recently faced downward pressure. The RBI's retention of GDP growth and inflation projections for FY2025 is reassuring,'' added Damania.

Also Read: Experts react to RBI’s August policy announcement: A cautious ’wait & watch’ approach

Kapil Gupta, Executive Director- Research, Nuvama Institutional Equities, said, ‘’Policymakers remain comfortable with the evolving growth trajectory and emphasized that RBI remains resolute in aligning headline inflation to the target of four per cent on a durable basis.''

‘’While core inflation is benign, stubborn food inflation poses the risk of second-round effects, and constant vigil is required. Thus, policymakers are in no rush to lower their guard. The trajectory of domestic food inflation and the evolving path of the Fed rate is the key monitorable in the near-term,'' added Gupta.