It was a big week for monetary policy with advanced economies raising interest rates in quick succession. While the European Central Bank was the first in recent times to raise three key interest rates by 25 basis points earlier this month, the US Federal Reserve raised its benchmark rate by a similar margin on Wednesday—its first hike since 2023. They were followed by the Bank of Japan on Friday, which raised its policy rate to a 31-year-high. Bucking the trend, the Bank of England left its rate unchanged, but is likely follow suit in the coming weeks.
The coordinated hikes raise the question whether we are heading into a synchronised monetary tightening phase, abruptly ending the easing cycle. Given the global uncertainties, higher energy prices and rising bond yields, chances are that inflation would remain above central bank targets for some time. This poses another key question: are interest rates going to stay higher for longer?
Regardless of whether these moves mark the beginning of a prolonged rate-hike phase, what’s unusual is that though the central banks are responding to rising prices, their economies are facing different problems. The US Fed was responding to persistent retail inflation amid resilient demand, whereas the ECB was dealing with an energy-driven inflation shock complicating growth prospects, while Japan is finally breaking from decades of ultra-low rates amid high inflation and a depreciating currency. A prolonged tightening by advanced economies—not completely ruled out yet—would make things difficult for emerging ones.
A higher rate in the US strengthens the dollar and puts pressure on other currencies because oil and gas, agricultural products and most other major imports are priced in the American greenback. Currency weakness can complicate central banks’ fight against inflation. Besides, a higher US rate would firm up global bond yields, prompting capital outflows from emerging markets and putting further pressure on currencies.
In India, retail inflation is well within the RBI’s tolerance band at present, but it may remain elevated enough to warrant rate hikes of 25-50 bps in 2026. While the RBI maintains that its policy decisions are based on domestic roadmaps and do not blindly follow the Fed footprint, a weakening rupee, persistent capital outflows and widening interest rate differential would complicate its job of balancing the inflation-growth dynamics.
