The US Federal Reserve left its policy rate unchanged on Wednesday. Chair Kevin Warsh said, "Inflation can be lowered to its target without having to throw sand in the gears." This pause gives India temporary relief, but rising outflows could soon force the Reserve Bank of India to change its strategy.
Summary
The US Federal Reserve's decision not to raise rates maintains the current spread between Indian and US bond yields, but this could be temporary relief. While RBI has so far been focused on the domestic economy, it may be prompted to act on the spread if outflows from India rise
The US Federal Reserve on Wednesday left its policy rate unchanged after delivering the first increase in more than three years last month. With inflation nearly double its 2% aim, it could be taking a big risk.
Letting price pressures flare could entrench inflation expectations. But chair Kevin Warsh seems to reckon it's better to wait-and-watch until the next review in December. Inflation can be lowered to its target without having to "throw sand in the gears" and slow growth, he said. Imminent mid-term elections may have also held Warsh's hand, although he refuted political influence.
For inflation to cool, oil prices must plummet. The odds of that don't look bright after US President Donald Trump's warning of possible attacks on Iran. The Fed's pause maintains the current spread between Indian and US yields. This relief may be temporary. Markets are pricing two more rate hikes by the Fed. These could accelerate outflows from India into US assets.
So far, the Reserve Bank of India has largely made rate decisions based on domestic conditions. But if outflows increase, it may be forced to react to the narrowing spread between US and Indian yields.