Mumbai: India’s move on Friday to raise fuel prices more than expected adds to bond market expectations that Reserve Bank of India (RBI) will raise interest rates by 50 basis points, not 25, when it reviews monetary policy next month.
While central banks often ignore one-off price rises, Friday’s move will push up monthly wholesale price inflation by 0.9 percentage point, the government said, exacerbating headline inflation that stood at a surprisingly high 10.16% in May.
“We now expect a 50 basis point hike in rates at the policy instead of 25 basis points earlier,” said RVS Sridhar, president and head of markets in treasury at Axis Bank, referring to the 27 July monetary policy meeting.
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A Reuters poll earlier this month found the median forecast among economists was for a 25 basis point rise in policy rates on that date. The RBI raised key rates by 25 basis points in March and again in April.
The yield on the benchmark 10-year bond shot up by as much as 11 basis points on Friday before closing up 8 basis points at 7.65%, a 10-day high.
The benchmark five-year swap rate rose to 6.80% from its previous close of 6.70%, ending at 6.78%. The one-year rate closed at 5.56%, up 13 basis points from Thursday’s close.
Interbank overnight rates have risen 1.5% since the end of May, acting as an effective rate increase and making it unlikely the RBI will raise rates before 27 July, dealers said.
“I expect the RBI to hike rates by 50 basis points at the policy. I don’t expect liquidity to ease before policy and so I don’t expect an off-cycle hike,” said Ananth Narayan G, head of rates and credit of south Asia at Standard Chartered Bank.
A panel of ministers, which had earlier delayed making a decision, on Friday increased prices of state-subsidised petrol, diesel, kerosene and cooking gas prices, which could help reduce the fiscal deficit from the projected 5.5% of 2010-11 GDP and free up revenues for other programmes.
“The fuel price hike is good for bonds in the long run as it will reduce the fiscal deficit. What we are seeing is a combined reaction of heavy (government bond) supply worries and fuel price hike,” Ananth Narayan said.
The fuel price increase will have a spillover impact on other prices and add pressure on the RBI to raise rates aggressively.
“The impact of this decision on inflation could be significant as prices of all subsidised fuel products have been increased,” said Gaurav Kapur, senior economist at Royal Bank of Scotland.
“That is going to feed into inflationary pressures in a more generalised manner.
The RBI may follow with a rate hike soon,” he said.
Last week, RBI governor Duvvuri Subbarao said the central bank will
continue to pursue its calibrated exit from loose monetary policy and that
with tightness in the cash market, the effective rate has moved to the repo
rate -- the rate at which it lends to banks -- from the reverse repo rate.