Even as analysts expected a benign tone from the US Federal Reserve on Wednesday, the June 12 commentary of the American Central Bank was anything but dovish. Setting aside the technicalities, the message is that the Fed is reluctant to go big on interest rate cuts as the fight against inflation is not over yet.

Despite easing inflation in the US, the Federal Reserve officials now project just one quarter-point cut in policy rates by the end of 2024, a significant shift from the projection of three rate cuts in the median estimate from March.

This disappointed a few in the financial markets. Before the release of the SEP, informally called dot plot, on June 12, interest-rate futures markets were anticipating two cuts this year, from the current target range of 5.25-5.5 percent for the federal funds rate.

What does this effectively mean?

The median estimates for the Fed-funds rate target range at the end of 2025 have increased by a quarter percentage point, from 4 percent to 4.25 percent, implying a cumulative reduction of one percentage point next year.

What does it mean for India?

Among other factors, the Reserve Bank of India too will pay heed to the signals from bigger central banks on rate cues. The Fed's plans for a rate cut this year could influence the thought process of the Monetary Policy Committee, but its actions will be driven more by crucial local factors.

During the monetary policy presser last week, a few questions were asked to the RBI brass on the implications of the US Fed rate moves. The response was on the expected lines and can be loosely summarised as: While we keep an eye on the Fed, our rate actions will be more dependent on domestic rate actions rather than what the Fed dictates.

But, looking back into history, one discovers that the RBI typically follows the cues sent out from the Federal Reserve.

To be sure, the RBI has its glide path on inflation targeting. The Indian central bank expected the inflation to average 4.5 percent in fiscal 2025 with Q1 at 4.9 percent, Q2 at 3.8 percent, Q3 at 4.6 percent and Q4 at 4.5 percent.

The May consumer price index-based inflation print showed a cooling off to 4.75 percent, a tad lower from the 4.83 percent a month back. The core inflation, or the non-volatile part of the inflation, too eased to less than 3 percent.

But, the 4 percent medium-term target is not in sight yet. The RBI will have to reevaluate the interest rate policy in the second half of the fiscal year looking at the inflation trajectory. In an ideal scenario, the window for rate cuts should open only next year, going by the RBI’s inflation projections.

The good news is that growth momentum remains steady and that is less one worry for the RBI. In a weaker growth scenario, the central bank would have been under pressure to support growth with early rate cuts. With growth projected at 7.2 percent for FY25, it has some elbow room to work with.

What are the key risks for RBI ahead?

Monsoon performance: A potential failure in monsoon distribution could impact crop production and supply and can offer surprise upside risks to food inflation. With food inflation still on the boil, monsoon is the key risk factor to watch out for at the moment.

Populist fiscal policy: After the surprise poll verdict that snatched away the majority mandate from the ruling BJP and forced it to form a coalition government with the Congress-led Opposition emerging as a mighty rival, the government may have to compromise on certain decisions under pressure from the alliance partners. If the government switches gears to a populist budget next month, yielding to pressure from allies, this could have ripple effects on the inflation management. The rate-setting panel may have to stay put on the policy rates for longer than expected.

Geopolitics and commodity prices: A surge in the global crude oil prices in the event of an escalation in the Israel-Iran conflict, coupled with the impact of a possible heatwave across India that may trigger a spike in food inflation, could distort the inflation blueprint for the rate-setters.

While the Fed’s rate direction is an important factor in influencing the Indian central bank, the RBI’s rate actions are likely to be more driven by domestic factors.