US Federal Reserve raises target interest rate by 25 bps

The US Federal Reserve (central bank of the United States) decided to increase the target interest rate by a mere 25 basis points. It may be recollected that earlier they had hiked rates by 75 bps on four occasions and then raised by just 50 bps in December. In February, they the rate hike is just 25 bps as evident from the Fed minutes. But the Fed is not done with rate hikes yet.

US inflation had crossed 8% last year before it tapered lower. While the Fed has been continuously raising Interest rates the inflation has continued to be sticky. One reason could be that the labour market is still very buoyant and so the rate hikes are not being transmitted into lower inflation. Fed stated that although inflation had eased, it still remains elevated and battle far from over.

To a large extent, these are the headwinds of the Russia-Ukraine war in the aftermath of the COVID pandemic. The revenge demand from a lot of helicopter money and the oil crisis caused by the war pushed up inflation to levels last seen in the US in the early 1980s. Government had provided a lot of benefits to people like near-zero interest rates which spurred demand. Also, the Just in Time (JIT) supply chain created a global embarrassment.

It was not just the war but also the sanctions that led to higher inflation. Even as the Fed has been relentless in its pursuit of inflation, there are now concerns that the global market may dip into recession this year due to weak demand caused by steep interest rates. On the positive side, the US has seen reduction in inflation, albeit gradual. This could impel the RBI to also stay on the hawkish side.