Monetary tightening at halfway mark, need to strike right balance
In the ongoing global monetary tightening marathon, we seem to have only reached the halfway point, marking the end of the beginning and not the end itself. How else can one explain the stop-start nature of interest rate hikes? Just when it seemed inflation was easing and policy rates have peaked, an increasing number of central banks are back to rate increases, some even after a steady pause. On Thursday, the Bank of England surprised markets, delivering a more-than-expected 50 bps hike, followed by the Norwegian central bank. The Turkish central bank went one step further with a staggering 6.5% point hike, taking the benchmark one-week repo rate to 15%, nearly smothering its currency. A few days before, the European Central Bank also signaled further increases in July.
Investor confidence across markets turned edgy this week, as the US Federal Reserve Chair Jerome Powell reiterated the need for additional rate hikes in coming months. In Europe, concerns about the economic outlook led to an inversion in the German yield curve, and though China’s central bank reduced two benchmark rates to bolster economic growth, the magnitude of rate cuts was so small that it couldn’t move the needle, leaving investors disappointed. In all, the hawkish central bank commentary caused a correction in global equities on Friday. Sensex, too, suffered a setback, crashing over 250 points—just a day after it managed to crack past the 63,000-mark.
As RBI’s Monetary Policy Committee (MPC) minutes show, Governor Shaktikanta Das, too, conceded that the job of taming inflation was half-done and that the MPC was still in a rate tightening cycle. The delay in the southwest monsoon is adding to concerns over El Nino posing an upside risk. The IMD maintains expectations of a normal monsoon, but then even a normal monsoon doesn’t rule out the possibility of declining crop production as seen in FY22 and FY23. As it is, vegetable prices are rising and risks to food inflation are skewed to the upside. Monsoon and crop production are crucial as they have a bearing on rural consumption, which in turn is critical for growth. As MPC’s external member Jayanth R Varma observed, the current policy was approaching levels that could potentially harm the economy considering the real interest rates are already positive. The MPC’s next policy actions must be well-balanced.