US Federal Reserve finally adopts a moderate tone

4 May 2023 , 10:34 AM

US Federal Reserve finally adopted a moderate tone yesterday, after more than 1 year of hawkishness. It increased benchmark interest rate by 25 basis points or 0.25%. This brings the Federal Funds rate in the range of 5% – 5.25%. Federal Funds Rate is the rate at which banks lend to each other, overnight, in US. It serves as the benchmark interest rate.

The more important part of the monetary policy announcement  was the Federal Reserve Chairman, Jerome Powell, saying that further interest rate hikes will be determined by the data that comes. This is a marked departure from the hawkish aggressiveness that Powell had adopted in the previous monetary policy announcements, over the past one year or more. In those meetings Powell would clearly say that more interest rate hikes are coming. This moderation in tone is being taken by many as end of the current cycle of interest rate hikes. US interest rate futures now indicate that US Federal Reserve may go for an interest rate cut in September.

This moderation in tone comes after a humbling experience for the US central bank. Its successive interest rate hikes over the past one year and more have failed to bring any significant decline in inflation rate. It was the major reason for the cause of failure of at least 3 US regional banks. The shutting down of First Republic Bank is the most recent banking failure. Interest rate hikes slowed the US economy. It delayed its recovery from the shock of Covid lockdowns.

An important point that was made in yesterday’s  announcement was the Federal Open Markets Committee (FOMC) saying that it will continue to reduce its holding of US treasury securities and other securities. This means that it will continue to reduce money supply for the time being. Central banks reduce money supply by selling the securities that they hold, in the market. They increase money supply by buying securities from the market.

This moderation in tone of US central bank is a welcome relief for India and the world. US economy is one of the engines of global economy. An economic slowdown there brings a slowdown in the global economy too. 

More interest rate hikes by the US central bank would have put further downward pressure on the value of rupee against the dollar. This would have made the Indian central bank  match the US interest rate increase with increase in interest rates in India. This would have proved disastrous for the Indian economy, that is suffering from the problem of high unemployment. India’s unemployment rate touched a 4-week high of 8.11% in April. This is completely opposite from the case in US, where unemployment rate remains low and jobs are growing robustly.