Markets
Developed economies lead the global race to ease monetary policy, for now
Summary
- The European Central Bank, Bank of Canada and the Swiss National Bank have started trimming interest rates, while the Fed is still in a wait-and-watch mode.
- Higher-for-longer interest rates in the US could put pressure on emerging economies that choose to pre-empt the Fed on interest rate cuts.
After hiking interest rates rapidly to counter high inflation in the aftermath of the covid-19 pandemic, central banks worldwide now have a common goal – easing monetary policy. But the speed at which individual central banks reach this goal is likely to vary, leading to policy divergence.
Monetary policy decisions are generally governed by a country’s economic and financial condition. The easing of inflationary pressures is a crucial factor currently at play. But ongoing geopolitical tensions, which have a bearing on global supply chains, have made things tricky. Many countries including the US and UK are also bracing for elections this year, and political and policy uncertainty is likely to remain until these are completed.
Also read | Expert view: RBI may implement shallow rate cut even if US Fed defers, says Rajani Sinha of CareEdge
Among developed economies, the European Central Bank, Bank of Canada and the Swiss National Bank have started trimming interest rates. The usual trendsetter for global monetary policy decisions, the US Federal Reserve, is still in a wait-and-watch mode.
As for emerging markets, key central banks such as the Reserve Bank of India (RBI), Bank of Korea, Bank of Indonesia and People’s Bank of China are maintaining the status quo on key lending rates. But for how long?
MPC members are divided
In India’s case, the recently released minutes of RBI’s June policy meeting point to a growing divide between members of the Monetary Policy Committee. Two external members voted for a 25-basis-points interest rate cut and a change in stance in June, versus just one in April. One basis point is 0.01%. Heat waves in various parts of the country have increased the risk of a further rise in food prices in the near term. The progress of the monsoon will be a key determinant of the food-inflation trajectory and therefore the timing of the interest rate cut.
Also read | Data explainer: Decoding the dissent of RBI’s doves, in 5 charts
According to economists at Vanguard Group, the strength of the US economy has forced the Fed to maintain its peak for longer. “Other central banks cannot delay policy normalisation much longer, given domestic economic weakness," they said in a note on 25 June. That said, this policy divergence may be temporary – once the Fed starts cutting rates, the policy directions of key central banks will be in alignment.
Until then, though, movements in foreign fund flows need to be monitored. Typically, money tends to flow out of countries where interest rates are cut as investors chase higher returns. This means higher-for-longer interest rates in the US could put pressure on emerging market economies that choose to pre-empt the Fed on interest rate cuts.
Also read: RBI’s rate-setting panel warns against premature change in policy stance
