Global Economies: Policy Divergence and Long-term Expectations

A marked divergence between countries is visible in their approach to post pandemic fiscal and monetary policy. The UK has hiked the base rate twice in the last two months to contain inflation despite being one of the worst affected in the last wave of the pandemic. In contrast to this, the approach of the Fed has been more studied and gradual. The Fed initially held the view that inflation was transient, and the result of revenge buying and pent-up demand. As time passed by the Fed realized that inflation was going to stay there for a longer time than expected. This led to the unwinding of the bond buying program, the unwinding is in its last phase. It was also announced after the last meeting of the FOMC that the Fed was gong in for the rate hikes soon, and that there would be at least two to three hikes during the current year.

The hike may come through in the next meeting. Interestingly, the last inflation updates for the US came in at 7.50 %, and it is the highest in several decades. The price rise has come from gasoline, fuel oil, used cars and trucks. The market rates have moved up, and the US 10 Treasury Bond is at 2.00%, signalling, a clear surge in interest rate expectations. Against, an inflation rate of 7.50% it is a negative real rate of 5.50 %, a situation that calls for some action that would at least gradually narrow the gulf. But there is a different picture against which the Fed may be strategizing against the enemy, the long-term prospects of average inflation may be around 2.50 % still, and therefore, the Fed could wait a little more and then strike. Also, by many estimates, the inflation may peak soon, and then it may start inching lower. These factors may prompt a more studied approach from the Fed. Back home, the RBI has made it amply clear that the policy will remain accommodative and cited some reasons why the growth-orientation or growth may be a more relevant variable given the fact that retail inflation is still within the threshold of policy target. More than inflation or growth, there is a big factor that the central bank must deal with, and that is the massive government borrowing program. Being the merchant banker to the government, the central bank has the responsibility of putting though the primary offerings on behalf of the government and ensure that it sails through smoothly and at the best average borrowing rates or coupons. But this is not an easy task given the magnitude of borrowing, and the fact that almost 40% of this amount will go into debt servicing. The last time around, the borrowing program just managed to push through supported by several liquidity support measures like GSAPs, a bond buying program to supply liquidity to the markets. The continuation of the accommodative stance may come handy for the central bank in designing appropriate policies at a later stage to make room for the primary issues. China continues with its cheap money policy for credit up to one year in a carefully crafted measure to ease the liquidity constraints faced by the real estate sector. This is somewhat closest to the ECB position of rate action only when it is extremely warranted. The standoff with Russia, and the escalation or de- escalation of the tensions may be of consequence to oil prices, and European markets as well. A rise in tensions will have a direct impact on oil prices, and thereby, on retail prices everywhere. How prolonged the confrontation will be is also a matter to be seen to gauge the long-term impact of such a development.



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