The cycle of aggressive interest rate hikes by global central banks, which began last February to fight raging inflation, appears to be coming to an end. While many countries such as India, South Korea, Australia and Indonesia have already paused policy rate hikes, both the US Federal Reserve and the European Central Bank lowered the quantum of hike in their policy rates to 25 basis points in their monetary policy meeting this week.

The Fed has also altered the tone of its statement significantly, dropping the phrase “the committee anticipates that some additional policy firming may be appropriate” and replacing it with the statement that future policy firming will depend on the incoming data. The ECB has however retained its stance of maintaining a “restrictive policy rate” to bring inflation down towards the long-term goal. With inflation continuing to be very high in the euro zone and the UK, the central banks in these regions may find it more difficult to reduce the pace of monetary tightening.

The US Fed’s action is, however, along expected lines as it has now hiked policy rate by 500 basis points since last February. The Fed Funds rate is currently close to the terminal rate projected by Federal Reserve Board members. While the rate-sensitive sectors such as housing are already slowing, the transmission to other sectors would happen with a lag and the Fed is right in waiting for future data points to decide on further action. The ongoing banking crisis, which has partly been caused by Fed’s aggressive rate hikes, could also be weighing on the Fed. Though the Fed is trying the contain the crisis with some ad-hoc solutions, it is impacting credit conditions for households and businesses. Inflation in core personal consumption expenditure (PCE) has reduced to 4.6 per cent in March 2023, down from the peak of 5.5 per cent last March. While this is still above the Fed’s desired long-term target of 2 per cent for PCE, long-term inflation expectation of households and businesses is well within comfort levels. Finally, slower growth in the first quarter of 2023 at 1.1 per cent could also have influenced the Fed’s decision.

The US central bank’s revised stance will leave room for the Reserve Bank of India (RBI) to extend the pause in its rate hikes. With credit conditions beginning to get tight in India and growth beginning to slow, the RBI can now watch incoming data before deciding on future monetary action. The fall in Indian 10-year bond yield to below 7 per cent following the FOMC meeting has provided a reprieve to the government, but the fall in yields may not sustain given the continued pressure on bond prices due to the large supply of government paper this year. The Fed’s action has however resulted in weakening the dollar considerably, with the dollar index sinking close to 100 on Thursday, which is helping the rupee stay firm.

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