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Federal Reserve of United States has cut rate in an emergency that has created opportunity for other central banks around the globe to cut rate, especially for those who held off so far out due to domestic and external concerns. It is expected that State Bank of Pakistan (SBP) will also follow the suite. However, many analysts expect the SBP to and opt for status quo in the upcoming monetary policy announcement. There are indications that inflation rate is easing in Pakistan, many attribute this to high base effect, delay in utility rate adjustments and price normalization in certain food categories rather than genuine price declines across the basket. It is also feared that if the central bank opt for cut in policy rate, Pakistan may experience reversal in the influx of ‘hot money’. There are ample evidences that the reversal has already started.
According to some analysts, Pakistan being less integrated with the global supply chains has historically remained largely insulated from the impact of ‘black swans’. Given limited financial integration with the globe, the country’s monetary policy setting has also remained more inward looking, dominated by domestic factors (inflation and domestic growth). Even in last two major instances (Dot-com bubble and Subprime mortgage crisis), when Fed opted for emergency rate cuts and subsequently EM/FM central banks went on an easing spree, Pakistan either maintained or hiked interest rates catering to the domestic need for tightening monetary policy. They also highlight that the comparison with the past may not hold now, since the situation has changed.
If history is any guide, an emergency rate cut by the US Federal Reserve generally triggers policy response from other central banks across the world, albeit the response varies in proportionality depending on domestic factors and impact of the event on a certain country. The policy response from the central banks is relatively quick and larger in scale when the economic repercussions of the event are more global. A review of 2007-08 financial crisis indicates that emerging market central banks kept their monetary firepower unused until the late 2008, when the severity increased and its impact started spilling over to global markets despite Fed being in action since late 2007, (Fed had cumulatively slashed interest rate by 425bps in a year).
The same is true in case of the Fed’s emergency rate cuts in the wake of the tech bubble and the 9/11 attacks. Taking cue from the past, it is anticipated that coronavirus has become a global pandemic and that too happening in a more interconnected world — should move central banks into action. The move has already started happening, though on a swift scale.
The US Fed announced a substantial half percentage point interest rate cut, bringing the target range for Federal Funds rate to 1.0-1.25%. The unanimously voted decision came in response to emerging risks to economic activity from the virus outbreak. The move followed the G7 group’s pledge to use ‘all appropriate policy tools’ to counter the adverse economic impact of Coronavirus. The Fed’s decision has set the ball rolling for other central banks across the world. The easing spree has already started, with the Australian and Malaysian central banks announcing rate cuts (25bps each) in their recent monetary policy announcements.
Bank Indonesia earlier last month announced a rate cut of 25bps. The Bank of Canada cut its benchmark rate by 50bps; making it the 5th central bank to announce easing following global peers. With talks of a coordinated policy response making the rounds, attention will shift towards European Central Bank and Bank of England) scheduled to announce monetary policies later this month.
The Fed delivered a surprise half-percentage point rate cut – bringing the target rate to a range of 1.00% to 1.25% – as cases of the new diseases exploded in South Korea and Italy and also gained in the United States, sending global stock prices into a swoon. Since then, cases have continued to rise, including the spread in the United States to more states.
Minneapolis Federal Reserve President Neel Kashkari said that he supported the US central bank’s emergency interest rate cut this week, and added the Fed could cut rates further if the impact of the coronavirus is worse than expected. “This was an insurance that we took out because nobody knows how bad the virus is going to be,” he said, and uncertainty means that companies are likely to pull back on activity. If in a few months it turns out the impact has passed, he said, the Fed could raise rates back up again.
With less room to cut interest rates than in the past, the Fed must act quickly in the face of threats to the US economic outlook like the coronavirus epidemic, the president of the Dallas Federal Reserve Bank, Robert Kaplan, said. “It’s wise to act sooner, more boldly, and it increases the likelihood that we’ll need to use less policy ammunition” later on, Kaplan told the Chicago Council on Global Affairs, on why he supported an emergency Fed rate cut earlier this week.
