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The Reserve Bank of India (RBI) increased the benchmark repo rate to 6.25% by 25 basis points (bps) on Wednesday after over four years. The last rate hike came in January 2014, when rates went up from 7.75% to 8%.

The hike officially marks the turning of the interest rate cycle, though banks have been raising rates on deposits and loans for a few months now. Interest rates started going down from 2015 and the last rate cut was in August 2017.

Why the rate hike now

A majority of observers were expecting no change in rates. Madan Sabnavis, chief economist at CARE Ratings said the RBI’s move has come in as a surprise. “We were expecting no change with a hawkish stance. But they have gone for a rate hike and a neutral stance. We interpret that they expect inflation to go up," he said.

The RBI’s main objective behind the monetary policy is to keep Consumer Price Index (CPI) inflation under check. CPI has been going up over the past few months. Also, between the last policy meet in April and now, crude oil prices have gone up a lot, adding to inflationary pressure. “Various indicators like inflation expectation surveys, crude prices or exchange rate depreciation were pointing towards inflation risks. RBI action today is a reaction to rising inflation threat," said Dharmakirti Joshi, chief economist at Crisil.

How does it impact you?

The immediate fallout would be that interest rates might begin to firm up. Banks have already been raising lending as well as deposit rates over the past few months. The most recent being just a couple of days ago. “Some banks have already raised MCLR (marginal cost of funds-based lending rate). The cost of borrowing will go up. But banks will also hike deposit rates and it will be good for savers," Sabnavis said.

Banks have been proactive in passing on rate hikes in the past to borrowers, but the transmission was not encouraging when rates went down. For instance, in 2015, the RBI cut rates by 125 bps, while banks pared base rates by only 60-75 bps, reflecting a lack of full transmission. The RBI too in its monetary policy reviews in the past has flagged the issue of rate cut benefits not being passed on to retail customers.

Whether there will be an immediate change by banks in deposit and lending rates will need to be seen, especially because most banks as well as markets had factored in the rate hike already. “Even without the RBI move, there was a de-facto rate hike in the system in G-Secs, corporate bonds, bank MCLR and deposit rates, all of these were anyway rising," Joshi said.

However, this might just be the first hike in a series of hikes to come. Sameer Narang, chief economist, Bank of Baroda, said CPI inflation, excluding food and fuel, and food inflation could increase to 5.7% and 3.1% in 2018-19 from 4.7% and 2.2% in 2017-18, respectively. “As a result, we expect RBI to raise rates by another 0.25% in the next six months as inflation is likely to remain above RBI’s target of 4%. Further policy action will depend on movement of oil prices, rupee and government’s MSP policy," Narang said.

So belt up for higher home loan rates soon.

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What experts say about the RBI policy

Dharmakirti Joshi, chief economist, Crisil

The RBI action today is a reaction to rising inflation threat. But there is a lot of uncertainty around global events and inflation. To keep their options open, they have maintained a neutral stance, which is prudent in an uncertain environment. Upcoming data will have a major role to play in how the central bank will act next.

R. Sivakumar, head, fixed income, Axis Mutual Fund

For the market, longer duration assets like government securities will see more pressure. Also, RBI usually does not stop with one rate hike. So probably this is a preparatory step for a series of hikes even though the timing may be uncertain. Over a period of time, impact on short-term and ultra short-term products will be minimal.

Madan Sabnavis, chief economist, CARE Ratings

The rates are going to go up. Some banks have already raised MCLR. The cost of borrowing will go up, so consumers will be affected, but deposit rates will also go up, and that will be good for savers. Market per se won’t be impacted as it has already buffered in a hawkish view. We would expect one more rate hike during the year.

Suresh Sadagopan, founder, Ladder7 Financial Advisory

The hike targets inflation, among other things. So the immediate fallout is bond yields have spiked and debt fund NAVs will fall. Also, loans could firm up. How soon will that happen needs to be seen and will depend on the liquidity condition of individual banks. But there’s a positive for senior citizens as deposit rates may go up.

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