The US Federal Reserve recently cut interest rates by 25 basis points, marking its second reduction in 2024. 

Key Highlights of the Reduction

• Interest Rate Reduction: A 25 basis point cut, signaling efforts to manage inflation.
• Future Outlook: The Fed remains open to further rate cuts based on economic performance, with a decision pending in December.
• Political Influence: US Federal Reserve asserted that the Fed’s decisions are unaffected by political changes or external pressures, including any influence from the White House.

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Relation between Interest Rate and Inflation

• Inverse Relation: The relationship between inflation and interest rates is fundamentally inverse, meaning when one rises, the other tends to fall. 
  • This connection is rooted in the Quantity Theory of Money, which indicates that changes in the money supply influence inflation.
  • This inverse relationship helps central banks manage economic stability.
  • By adjusting interest rates, central banks can influence inflation and purchasing power, aiming to maintain price stability and support a healthy economy
• High Interest Rates: When the central bank raises interest rates, borrowing becomes more expensive. 
  • This reduces the money supply, as people and businesses are less inclined to take out loans. As a result, spending declines, leading to lower demand for goods and services, which helps control and reduce inflation.
• Low Interest Rates: When interest rates are low, borrowing is cheaper, leading to an increase in the money supply. 
  • People and businesses are more likely to spend and invest, boosting demand for goods and services. With demand outpacing supply, prices rise, driving up inflation.

Market Reactions and Global Implications

• US Debt and Inflation Concerns: Following the rate cut, US debt interest rates spiked, with analysts warning of inflationary pressures from Trump’s proposed tax cuts and tariff plans.
• Impact on Global Currencies: A lower US interest rate could make investments in other currencies more attractive, especially in emerging markets such as India. 
  • This could drive higher returns for currency carry trades, attracting foreign investments in countries with higher rates.

Potential Impacts on Indian Economy

• Carry Trade Opportunities: As the US rate declines, the difference between US and Indian rates may widen.
  • This creates attractive opportunities for currency carry trades in India, potentially increasing foreign investments in Indian bonds and equities.
• Boost to Global Growth Prospects: Lower rates in the US might stimulate its economy, which could have a positive ripple effect on global growth.
  • India, alongside other emerging markets, may benefit from this potential economic uplift, especially as China contends with a real estate crisis.
• Investor Interest in Emerging Markets: With lower returns on US debt, investors may be drawn to emerging markets like India, seeking higher returns.
  • This trend could bolster Indian equity markets and bring in increased foreign capital.

Domestic Monetary Policy Considerations in India

• The Reserve Bank of India (RBI) has raised rates by 250 basis points since 2020, reaching 6.5% to control inflation.
• However, given the US Fed’s easing stance, the RBI may adopt a cautious approach in its upcoming Monetary Policy Committee meeting on December 4-6. 
• Any delays by the Fed in further cuts could influence RBI’s decisions on its own rate adjustments.

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Global Factors Impacting Indian Economy

• China’s Economic Stimulus: China is expected to launch a significant stimulus package, which may shift foreign portfolio investments (FPIs) away from India.
  • Heightened tensions from Trump’s proposed tariffs on Chinese goods may further incentivize China to adopt aggressive fiscal measures, potentially decreasing India’s appeal to FPIs.
• Bank of Japan’s (BoJ) Expected Rate Hike: The BoJ is anticipated to raise rates in December, which could impact the yen carry trade and potentially increase market volatility.
  • A rate hike could lead to a shift in global investment patterns, influencing India’s equity and currency markets.

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