A look at the return to pre-Covid rates: the markets are preparing for a “no-brainer” rise

After the repo rate hiked 40 basis points to 4.40% last month, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) is expected to proceed with another rate hike to combat the level inflation rate at its next meeting. Wednesday.

Bond and equity markets are already positioned for an early hike in the repo rate – the main policy rate at which RBI lends funds to banks.

The broader market expectation is that the central bank will raise the repo rate by around 40-50 basis points (bps) at the June meeting. Any lesser rate hike will be a pleasant surprise and short-term bond yields could dip slightly.

RBI Governor Shaktikanta Das has already hinted at the rate hike. “The expectation of a rate hike is obvious. There will be some increase in the repo rate. By how much, I won’t be able to say now, but to say that (it will be increased) to 5.15% now won’t be accurate,” he said on May 24.

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“With inflation persisting above 6% (the upper limit of the tolerance band) and continued growth, we expect the RBI MPC to increase the repo rate by 40 basis points in June and 35 basis points We should point out that in the interest of standardized steps, the odds of getting a 50 + 25 basis point upside combination are also quite high,” said a Bank of America Securities report.

The bottom line is that the RBI MPC should emerge from ultra-accommodation by August and bring the policy repo rate back to the pre-pandemic level of 5.15%.

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“As a result, until then the RBI MPC is likely to maintain a dovish stance while focusing on withdrawing accommodation. Thereafter, as inflation continues to remain high, we see the RBI MPC taking the political repo rate to 5.65% by March 2023,” he added.

On May 4, ending the low interest rate regime, the RBI raised the repo rate by 40 basis points to 4.40% and the cash reserve ratio (CRR) by 50 basis points to 4. .50% to bring down high inflation and tackle the impact of geopolitical tensions.

However, the central bank maintained the accommodative monetary policy at an unscheduled meeting of the MPC.


Liquidity level under control

To combat soaring inflation and contain excess liquidity, the MPC – in a surprise move – raised the repo rate and CRR on May 4. be comfortable with the current level of liquidity.

Since then, banks have increased pension-related lending rates and the marginal cost of funds-based lending rates (MCLR), resulting in higher monthly equivalent payments (EMI).

“We expect the RBI to raise interest rates by 25 to 40 basis points at the June policy meeting. There is no doubt that inflation has increased in India, and this is largely attributable to the environment global geopolitics,” said Umesh Revankar, Vice President and Managing Director of Shriram Transport Finance.

June’s policy will be important from the perspective not only of the rate action, but also of the RBI’s thoughts on growth and inflation, analysts said. “While the potential action of monetary policy is tied to its projections on growth and inflation, markets will be looking for direction from the central bank on these two indicators,” said Madan Sabnavis, chief economist, Bank of Baroda.

“We expect the RBI to increase the repo rate by another 35-40 basis points at the June meeting. inflation risks,” said Pankaj Pathak, Fixed Income Fund Manager, Quantum AMC.

The recent announcement on fuel tax cuts and reduced import duties on edible oils will bring some comfort to the RBI.

The RBI’s surprise CRR hike early last month fueled expectations of another CRR hike in June policy. However, excess liquidity in the banking system has fallen sharply over the past three weeks. Currently, the net excess liquidity parked under the RBI LAF window is close to Rs 3 lakh crore. “We believe the RBI will be comfortable with this level of liquidity at this stage. Thus, this may keep the CRR rate unchanged,” Pathak added.

The off-cycle rate hike fueled expectations of the RBI’s rate hike decisions. “With the U.S. still not caving in to moderating the pace and quantum of rate hikes, and inflation showing no immediate signs of slowing, it looks like another irreproachable move to raise rates. in policy going forward. The amount of the rate hike (40-50 basis points in our view) will be a key determinant in the extrapolation of the terminal repo rate for FY2023,” said Lakshmi Iyer, Director Investments (Debt), Kotak Mahindra AMC.

Although aggressive tightening is already priced in by bond markets, policy stance will continue to play an important role in the direction of bond yields.

The rise in the repo rate means that the cost of funds for banks will increase. This will prompt banks and NBFCs to raise lending and deposit rates in the coming days. However, analysts say consumption and demand may be affected by rising repo rates.

Prior to the May 4 hike, the Reserve Bank last raised the repo rate by 25 basis points to 6.50% in August 2018. From 8% in January 2014, the repo rate fell to 4% in May 2020 after the Banking regulator has cut rates over the years to boost growth – the last cut was 40 basis points in May 2020 to deal with the negative impact of the Covid-19 pandemic.

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