Economic slowdown may force central banks to unwind interest rates

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With a global economic slowdown looming on the horizon, central banks across the world may  start unwinding rates in unison as inflation comes off the boil and slowdown begins to bite, according to a research report by State Bank of India (SBI).

In 2022, financial markets remained volatile and edgy due to global spillovers such as the Russia-Ukraine war, sanctions imposed on Russia by the West, and disruptions in global supply chains.

This led the central banks to adopt a rate hike cycle, which was in complete contrast to the post-global financial crisis in 2008 when all central banks had cut rates together. However, in 2022, central banks decided to take an exit from easy monetary policy separately, including India.

Also Read: RBI Financial Stability Report: High investment fluctuation reserve helps banks to absorb treasury losses in Q1 FY23

Policymakers need to control inflation without harming economy and financial markets, said SBI in its report. The higher cost of capital and lower operating margins impacts the growth and competitive landscape favoring established market players than the new entrants.

While the Indian equity markets were volatile in 2022, a granular look at the data reveals that both in terms of returns and volatility, they had logged in the best performance on a relative scale, according to the report.

Equity and bonds are expected to become less correlated when the economic cycle slows. Challenges for investors rise when both bond prices and equity prices fall together. Equity markets factors news, positive or negative, to reasonably value the stocks. Investors tend to choose asset allocation in markets by comparing yields derived by short duration and long duration government securities, said SBI.