The latest data from the US shows that inflation, which had remained sticky, is finally easing. Mint looks at whether the interest rates in the world’s largest economy, which are at a 23-year high, will now start dropping and what the implications are for India.
According to the US Bureau of Labour Statistics, inflation as measured by the Consumer Price Index has declined to 3% in June from 3.3% in May 2024. This the third straight month of decline in inflation. Core inflation, excluding volatile food and energy prices, rose by just 0.1%—the slowest increase since January 2021. That apart, the unemployment rate rose to 4.1% in June from 3.7% towards the end of last year and economic growth slowed down to 1.3% in Q1 of 2024 from 3.4% in Q4 of 2023. All these mean the Federal Reserve’s effort to tackle inflation is finally paying off.
At a Senate hearing on Capitol Hill last week, Jerome Powell, chairman of the Federal Reserve, said that the US is back on the “disinflationary path”. Post the covid-19 epidemic, inflation in the US shot up to 9.1%. To combat it, the Federal Reserve increased interest rates 11 times in 2022 and 2023 and took it up to 5.5%—the highest in more than two decades. Though inflation has since dropped from the peak, it has refused to decline below 3%. Therefore, Powell wants more confirmation that inflation is moving sustainably towards the Federal Reserve’s target of 2% before cutting interest rates.
No. Last December Powell and other officials jumped the gun and indicated that the process of cutting interest rates will begin in mid-2024 as inflation had cooled significantly. But inflation, to their surprise, rose in February and March, ruling out any rate cuts. This time around the Fed wants to be doubly sure before committing to a timeline.
Powell last week also talked about the risk of keeping interest rates high for too long. It can cause the US economy to crash land, push it into a recession and lead to massive joblessness. With clear signs of the economy slowing, pricing pressures easing and the job market cooling, economists expect cuts to happen from September if the present inflationary trend continues. Trends will be available this month when the Federal Open Market Committee, the rate-setting body of the Federal Reserve, meets.
A higher interest rate in the US means higher bond yields there. Foreign investors then pull money from emerging markets like India and invest in the US. In April and May they did just that when it became clear that rate cuts in the US are unlikely (fear of political uncertainty post-election in India was also a reason). A rate cut will drive more investments into India, strengthen the rupee, lower the cost of imports and thereby cool inflation here. Lower inflation will then set the stage for a faster pace of India’s economic growth.
