Central banks, including RBI, may raise interest rates to combat inflation

ECB President Christine Lagarde has already said the bank till hike rates, if needed

The current mood among central banks, including the Reserve Bank of India (RBI), seems to be to continue increasing rates till inflation is back in the comfort zone.  

According to a Bank of Baroda note, a slew of macro indicators in the US have increased the probability of a higher Federal Reserve rate in the near term.

Core personal consumption expenditure deflator – a measure of the spending on goods and services (excluding food and energy) by people of the United States – rose by 0.6 per cent in January 2023 against an estimated 0.4 per cent on month-on-month (MoM) basis.

There has also been an upshot in personal spending by 1.8 per cent on a MoM basis against an estimated 1.4 per cent in January 2023.

The inflation expectation of the University of Michigan also remained elevated. The new home sales data, too, pointed towards revival with a 7.2 per cent MoM increase against an estimated 0.7 per cent increase in February this year.

The money market is now pricing for a peak in Fed rate at around 5.4 per cent in July 2023, the note said.

European Central Bank (ECB) President Christine Lagarde has already said that the bank would resort to more hikes, if necessary, to bring inflation back to its target of two per cent in a timely manner.

The RBI's rate-setting body, the Monetary Policy Committee, too, has waved a red flag on inflation in its latest policy in February. It has also indicated that it will be more watchful on inflation as core inflation remains high.

"Now that January inflation has come in at 6.5 per cent and will continue to remain high due to the weight adjustment in cereals, the RBI’s position stands vindicated," Bank of Baroda Chief Economist Madan Sabnavis said.

However, within the MPC, there are differing views, which will finally determine the stance taken by the RBI, he said.

Also, if the Fed and ECB continue to raise rates, it will impact the flow of investment as well as currencies, which can cause distortions within. This is something the RBI will also be considering when it takes a call, he said.

It does appear that there will be a long pause, given this uncertainty, which will not exclude raising the repo rate if inflation again hits the 6.5 per cent mark in the next couple of months, he said.