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  • Trade war has just changed the equation for global central banks
  • March 24,2018

  • blog(By D K Aggarwal, Chairman and MD, SMC Investments and Advisors Ltd.)  Central banks across the globe have been moving almost in synchronized steps since 2017. One common feature of their unconventional policies was a large expansion of balance sheets and defined inflation target, although they have adopted a variety of approaches.

    With strong growth signs visible in the global economy, major central banks have moved slowly to reduce stimulus, as inflation remains below their targets. Changes in interest rate targets have been made so far in response to various market indicators to forecast economic trends.

    Additionally, central banks intend to keep markets on track in order to achieve the defined inflation targets.

    The US Fed raised rates in its first meeting under Chairman Jerome Powell, indicating that the economy was growing stronger with very low unemployment and rising wages.

    At the same time, the US central bank stuck to its plans for three rate hikes this year, reinforcing the message that it plans to maintain steady rate increases. China’s central bank, too, increased the cost of short-term loans to commercial lenders recently.
    Meanwhile, the recent trade spat has dented the confidence of the ECB, which otherwise has a rosy outlook for the euro area on the back of rising investments, falling debt levels of private sector and capital ratios of healthy banks.

    The threat of a global trade war and a steady message from the US Federal Reserve on interest rates would also impact Japan, as it continues to have a negative interest rate policy.

    Undoubtedly, the previous tightening cycles by the Fed prompted many other central banks to move in lockstep. However, things were different at this time. Sub-par inflation and healthy foreign reserves have reduced the need to move quickly and no central bank would ignore the risk of a trade war that the US president has initiated.

    Back home, the Reserve Bank of India has shown its concerns over inflation. However, it is expected to maintain status quo on interest rates per se, as the latest two readings of retail inflation came lower than what was perceived earlier and GDP growth data for last quarter and latest industrial data print came in better than before.

    To conclude, fear of trade war will continue to dampen market sentiments globally, as investors are worried that trade tensions will wreak havoc on the global economy. Stock markets are coming off in anticipation of the implication of protectionist policies. At this point in time, no clarity is emerging on the incidence and impact of such polices.

    Also, the interest rate hike by the US Fed is expected to narrow the spread between Indian government debt and treasuries. This may dent the Indian rupee further. Since markets move ahead in anticipation, we have already seen some deceleration in the rupee.

    Undoubtedly, market participants will continue to keep their eyes on foreign fund inflows. At home, the situation demands close policy monitoring and close international reference, before there is any interest rate hike by RBI.


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