US Fed Policy: Amid Rate Cut Expectation, RBI Likely To Maintain Focus on Domestic Factors

Regardless of whether the Federal Open Market Committee reduces its key interest rate by 25 or 50 basis points, the Reserve Bank of India is anticipated to maintain its focus on domestic factors. Nevertheless, the central bank’s next rate decision will also be influenced by the effects of weaker global demand.

With inflation nearing the Federal Reserve’s 2% target and the economy showing signs of slowing, the Fed is expected to begin rate cuts, with the first anticipated on Wednesday. However, the probability of a large cut has lessened due to an unexpected increase in core inflation in August. While markets are divided on the size of the initial rate cut, India’s central bank may not immediately respond to the Fed’s actions.

"We maintain that the Fed's pivot will precede and influence the RBI's change in stance and rate action," said Madhavi Arora, lead economist at Emkay Institutional Equities. She added that remaining relatively hawkish and emphasising the still-elusive durable 4% inflation target will only create unwanted INR carry, particularly when the RBI is still dealing with an excess liquidity issue, especially in the first half of the fiscal 2024-25.

The favourable global conditions, including the Federal Reserve’s move towards monetary easing, soft crude oil prices, and stable domestic inflation, should give the Reserve Bank of India room to shift its policy stance to neutral in October, Suvodeep Rakshit, senior economist at Kotak Institutional Equities said.

He explained that the liquidity conditions and overnight rates have been kept low and said, "On the policy front, while domestic factors will be key, the RBI’s decision will also be impacted by spillovers from the global monetary policy cycle, uncertain global demand and FX volatility."

"We maintain our call of a shallow rate-cut cycle of 75-100 basis points starting in December 2024 as inflation begins gliding toward 4% in FY26, and global growth conditions begin showing more visible signs of deterioration," he added.

The Fed dot plot is important to see how deep the Fed sees the cutting cycle, Dhiraj Nim, economist and FX strategist at ANZ said. The market is aggressively positioned on rate cuts and the Fed's commentary on growth and the labour market will be scanned by recession watchers, Nim explained.

The Fed cutting is positive in terms of flows but a lot is already priced in, Nim added. Only a dovish surprise will spur significantly more inflows. If the narrative remains of a soft landing, then it should be positive for inflows and the rupee, Rakshit said, adding that a recessionary scenario will be negative for inflows and the local currency.