Shifting expectations
No respite from US inflation and geopolitical tensions
Despite the most aggressive and coordinated monetary policy tightening in decades, the global economy’s strength has surprised many economists. The US economy, in particular, has demonstrated greater resilience than initially anticipated. The latest World Economic Outlook (WEO) of the International Monetary Fund (IMF), released this week, expects the global economy to grow by 3.2 per cent in 2024, 10 basis points higher than its January update. The US economy is expected to expand by 2.7 per cent in 2024, 60 basis points higher than the January projection. The projection for the euro area, however, has been lowered by 10 basis points and is expected to expand under 1 per cent. Meanwhile, growth projection for India has been improved by 30 basis points to 6.8 per cent for 2024-25. Projections for China have been left unchanged at 4.6 per cent.
As the WEO has underscored, stronger than expected private consumption, along with a tight labour market, has supported aggregate demand in some advanced economies, including the US. Further, higher government spending has supported aggregate demand. Among large economies, compared to October 2022 projections, additional budgetary support in the US was about 2 per cent of gross domestic product, while it was a modest 0.2 per cent in the euro area. Households in advanced economies are also drawing down savings accumulated during the pandemic. On the supply side, the easing of supply-chain pressures after the pandemic helped increase output. Thus, the risk of the so-called hard landing has not materialised so far. However, as the restrictive monetary policy stance begins to affect demand and output, central banks are again in focus with expectations of policy-rate reductions.
In this context, the IMF notes that with inflation projected to decline towards the medium-term target in advanced economies, major central banks are expected to start lowering interest rates in the second half of 2024. By the fourth quarter, for instance, the US Federal Reserve is expected to reduce the policy rate from 5.4 per cent to 4.6 per cent, which is similar to the projection made by Fed officials in the last meeting. However, the last stretch of disinflation to reach the inflation target is looking challenging in the US. The inflation rate for March, at 3.5 per cent, surprised analysts on the upside and reduced the possibility of policy-rate reduction. Federal Reserve Chairman Jerome Powell noted this week that attaining the target of 2 per cent could take longer than expected and the central bank would maintain the current policy rate for as long as necessary. A shift in expectations on Fed policy action can significantly increase financial market volatility and affect capital flows. Renewed tensions in West Asia will only complicate matters further.
Although India has large foreign exchange reserves and portfolio flows have been positive in recent months, a significant increase in crude oil prices owing to geopolitical tensions and a spike in US bond yields, which have inched up over the past few days, can increase macroeconomic challenges. In this regard, the Monetary Policy Committee (MPC) of the Reserve Bank of India did well to leave the policy rate unchanged in its last meeting. Given the disinflation challenges being witnessed in the US, and potential volatility in oil prices, the wait to attain the 4 per cent inflation target could get longer for the MPC.