RBI may take cue from BoE, US Fed rate hikes

Interest rate hikes by global central banks, including the US Federal Reserve and Bank of England, have increased the possibility of an extended rate hike cycle by the Reserve Bank of India and, consequently, a higher terminal repo rate, economists and market participants said.

On Wednesday, the US Fed hiked the policy rate by 75 basis points to 3.75-4% while hinting at a lowering of the quantum of rate hikes by the next or the following meeting. However, it also said that the terminal rate, or the peak benchmark interest rate, is likely to be higher than earlier expected. Bank of England, too, hiked the benchmark interest rate by 75 basis points and hinted at increasing rates further to bring inflation down to the target level.

Responding to the rate action, the bond markets in India ended nine basis points higher to 7.49%, while the rupee ended at 82.89 against the dollar from the previous close of 82.79

Economists and bond traders expect RBI to prolong the rate hiking cycle, which was expected to end early next year. They also expect the terminal repo rate to touch 6.5% by next year. That said, this is unlikely to impact the policy review in December when RBI may hike rates by 35-50 bps.

“Our policy may have to be aligned with Fed due to currency concerns, though not to the extent of the magnitude of rate hikes. If Fed is hiking, we will have to continue hiking. If the Fed cycle is getting elongated, then it’s not good news for developing economies like India,” said Naveen Singh, head of trading at ICICI Securities Primary Dealership.

“For India, we continue to expect a 35 bps rate hike in the upcoming policy review in December. Anticipated comfort on inflation is likely to prompt the MPC to pause, with two out of six members already in favour of such a move. However, the risk of disorderly exchange rate movement (not our base case) potentially raising the likelihood of further moderate rate hikes cannot be ruled out,” said Vivek Kumar, an economist at QuantEco Research.

In the September policy, RBI governor Shaktikanta Das referred to the aggressive monetary policy actions by the advanced economies as the third major shock after covid and the Russia-Ukraine war.

RBI has raised policy rates by 190 basis points since May, but India’s retail inflation continued to remain above its target of 2-6% for three consecutive quarters.

Defending its policy actions so far, RBI is likely to write a letter to the government explaining the reasons behind the failure to meet the inflation target, certain remedial actions that the central bank proposes to take, besides an estimated timeline to achieve the inflation target.

“The RBI had highlighted that the Fed was the third shock after covid-19 and the war in Ukraine. After maintaining that it is guided by domestic considerations, last policy was the first time RBI said that Fed is an important part of our policy formulations,” said Madan Sabnavis, chief economist, Bank of Baroda.

Given that the letter on inflation targeting failure is being discussed today, RBI will probably align rates with Fed to send the right signal to parliamentarians that it is doing enough and will continue increasing rates, Sabnavis said, adding that whether it will be a more moderate 25-35 bps or not, one will have to wait and see.

Shayan Ghosh contributed to the article.