In a synchronised move central banks in major economies had to raise policy rates to their peak levels during post-pandemic times to fight inflation.
Inflation is well on the way to reaching targets with front-loaded monetary policy tools working actively. Though upside risks to inflation cannot be completely ruled out due to geopolitical uncertainties, central banks have been maintaining a pause in interest rates for quite some time.
The US Federal Reserve in its recent FOMC meeting kept the policy rates at the existing level of 5.25-5.50 per cent which has been unchanged since July 2023.
It further affirmed its intention to implement a three-quarters of a percentage point rate cut this year though its inflation is still hovering around 3.2 per cent in February 2024 down from its peak level of 9.1 per cent recorded in June 2022.
Markets buoyant
The IMF in its January 2024 report expects the US economy to grow at 2.1 per cent in 2024 and 1.7 per cent in 2025. The US Fed’s positive stance is already reflected in the buoyancy of stock markets and optimism set in financial markets.
Bank of England kept its policy rates intact at a 16-year high of 5.25 per cent since August 2023 to fight inflation, though it has hinted at cuts going forward. According to the IMF, the UK economy should be growing at 0.6 per cent in 2024 and at 1.6 per cent in 2025.
It is also noteworthy that the ECB kept the three key interest rates — 4.50 per cent (refinancing operations), 4.75 per cent (marginal lending facility), and 4 per cent (deposit facility) unchanged. Although most measures of underlying inflation have eased further, domestic price pressures remain high, in part owing to strong growth in wages.
The economy is expected to grow at 1.5 per cent in 2025 and 1.6 per cent in 2026, supported initially by consumption and later also by investment. ECB is thus well-positioned to reduce rates going forward.
The People’s Bank of China (PBOC) cut the reserve requirement ratio (cash that the banks are required to hold) by 50 basis points effective from February 5 to inject 1 trillion yuan to pump liquidity into the markets. The move can ease liquidity conditions and foster growth.
RBI’s path
Against the backdrop of robust GDP growth and inflation moving down to 5.09 per cent in February, it is expected that policy rates, at a standstill of 6.5 per cent since December 2022, will remain intact during the next Monetary Policy in April. RBI is committed to bringing down the inflation to 4 per cent mark on a durable basis. Logically, the direction of the monetary policy of RBI should be customised to domestic needs but it will be difficult to decouple itself from global winds.
Banks will have to face elevated interest rate risks at the beginning of the rate-cutting cycle as repo-linked loans will get repriced immediately while the term deposit costs will linger on for some time until their maturity.
In this phase, the industry, trade, commerce, and capital markets will be in a buoyant mood due to lower borrowing costs while banks will have to rework their risk management strategies to protect their net interest margins.
The demand for credit will rise while resource mobilisation will continue to be a daunting challenge. Risk-sharing strategies, augmenting alternate resources, and right pricing of liability products will have to work together for the impending soft landing.
The writer is an Adjunct Professor, at the Institute of Insurance and Risk Management, Hyderabad. Views expressed are personal