Monetary policy path

Global financial conditions are expected to ease

The Federal Open Market Committee of the US Federal Reserve triggered a rally in stock markets following its two-day meeting on Wednesday by indicating that it remained on course for a 75 basis points reduction in the policy interest rate this year, despite an uptick in the inflation forecast for the year. Although the Fed was not expected to reduce the policy rate in the March meeting, some market participants were concerned that the recent inflation conditions could delay or reduce the possibility of rate reduction. Indeed, the latest projections by Federal Reserve board members and Federal Reserve Bank presidents showed the median core inflation rate for 2024 at 2.6 per cent, compared to 2.4 per cent in December projections. The projection for the current year’s economic growth has also been revised from 1.4 per cent in December to 2.1 per cent.

Given the pace of economic growth and pressure on prices, attaining the 2 per cent inflation target on a durable basis may take some time. As Federal Reserve Chairman Jerome Powell noted in his remarks: “It’s going to be a bumpy ride.” Nonetheless, the level of the target range for the federal funds rate at 5.25-5.5 per cent — over a two-decade high — leaves room for starting the rate-cutting process. However, to what extent the Fed is able to cut rates in the current year and the next remains to be seen. While the market is waiting for the Fed to start cutting rates, the Bank of Japan (BoJ) increased its policy rate for the first time in 17 years this week. It also became the last central bank to end the negative policy rate regime on Tuesday and raised the policy rate to the range of 0-0.1 per cent. The BoJ also decided to end its yield curve control programme along with the purchase of exchange-traded funds. However, the central bank will continue to buy long-term government bonds from the market as required.

The idea of a negative policy interest rate was always controversial and it is not clear whether economies actually benefited a great deal from it. Besides the BoJ, other central banks like the European Central Bank (ECB) and central banks in Switzerland and Sweden experimented with negative interest rates. It started in the 2010s, when central banks, particularly in Western economies, were trying hard to push up economic activity in the aftermath of the global financial crisis. The sovereign debt market problems in some European countries also affected the economic outlook, prompting central banks to do more to support economic activity. However, Japan used it as another tool in its persistent fight against deflation. Notably, the US Fed never pushed its policy rate into negative territory.

Given the limited role of Japanese capital in the global financial market, the policy action has had a limited impact. Also, in the given economic situation, the BoJ is unlikely to tighten policy further in the foreseeable future. Thus, markets would remain focused on the Fed and, to some extent, the ECB. As things stand, it is reasonable to expect an easing of global financial conditions over the coming quarters, which should help increase capital flows to an emerging market country like India. In such conditions, policymakers would need to guard against undue currency appreciation and asset price inflation.