U.S. Fed aggressively cuts interest rate by 50 bps; will RBI follow suit?

In a surprising move, the U.S. Federal Reserve on Wednesday aggressively cut interest rates by a half-point for the first time in four years since the pandemic’s early days in 2020. The policy decision, announced at the end of the Fed’s two-day policy meeting, marks a major shift in the U.S. central bank’s fight against curbing inflation as the officials believe it would boost the job market. The cut in fed rates will provide big relief to households and businesses as it would bring down the cost of borrowing, which may lead to capital inflows into emerging markets like India. 

The Federal Open Market Committee (FOMC) voted 11 to 1 to cut the benchmark rate by 50 basis points to a target range of 4.75% to 5%. In its official statement, the Fed said that the committee aims to achieve maximum employment and inflation at the rate of 2% over the longer run. “The Committee has gained greater confidence that inflation is moving sustainably toward 2%, and judges that the risks to achieving its employment and inflation goals are roughly in balance.”

“The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate,” it added.

According to industry experts, this is a very bold surprise move by the Fed as Wall Street was expecting a 25 bps cut in interest rate. The experts believe there could be a series of interest rate cuts leading to the U.S. elections, scheduled for November 5, 2024.

“This certainly marks the beginning of a pivot in interest rates after more than four years, though the final impact on the markets will be dictated by other economic data such as labour rates, inflation, unemployment rate etc that still needs to be keenly observed, says Dhawal Ghanshyam Dhanani, Fund Manager, SAMCO Mutual Fund. 

Will RBI follow the suit of the U.S. Fed?

Historical trends suggest that the Reserve Bank of India (RBI) aligns its policy direction with the U.S. Federal Reserve more often than not. If the American central bank announces a series of rate cuts ahead of the elections, the RBI may follow suit to support economic growth.

“The U.S. isn’t the first economy to have cut rates, the UK, Eurozone and Canada have already begun this cycle while India is on a wait and watch mode. History shows that more often than not India has followed the US in any interest rate pivot and this time too there is high probability that we will follow suit,” says Dhanani of SAMCO MF.

V K Vijayakumar, Chief Investment Strategist, Geojit Financial Services, believes that the rate cuts by the Fed will pave the way for rate cuts in India, too. “CPI inflation coming below the RBI’s target of 4% during the last 2 months will facilitate rate cuts. Two rate cuts of 25bp each are possible in India before March 2025. In brief the market scenario is turning favourable for rate-sensitives, particularly banking."

He says more rate cuts are expected from the Fed, going forward. “The rate projections are 4.4% by end 2024 and 3.4% for end 2025. These will be big declines from the present 4.75-5% rate.”

The RBI has kept the interest rate unchanged since February 2023, while the repo rate was hiked six times from 4 to 6.5% between May 2022 and February 2023. In the last meeting in August, four of six MPC members voted in favour of the status quo while two external members called for a rate cut.

Several banks and brokerages expect the RBI to maintain the 'status quo' when it comes to key lending repo rates during 2024, primarily due to uncertainty over food inflation.