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India raises rates at surprise monetary policy meeting, bond yields jump

India raises rates at surprise monetary policy meeting, bond yields jump
© Reuters. FILE PHOTO: A security guard’s reflection is seen next to the logo of the Reserve Bank Of India (RBI) at the RBI headquarters in Mumbai, India, June 6, 2019. REUTERS/Francis Mascarenhas/File Photo

By Swati Bhat and Nupur Anand

MUMBAI (Reuters) -India’s central bank raised its main lending rate off record lows in a surprise move on Wednesday to contain rising inflation, shocking markets and pushing the benchmark 10-year bond yield to its highest levels in three years.

The Reserve Bank of India raised the repo rate – the rate at which it lends to banks – by 40 basis points to 4.40%, in its first change in the rate in two years and its first rate hike in nearly four years.

Most analysts had been expecting a rate rise at the next scheduled meeting of the bank’s Monetary Policy Committee in June, and markets were caught off guard as they were unaware that the six-member panel had met off-cycle.

“The MPC noted that domestic economic activity is progressing broadly on the lines anticipated in April,” Governor Shaktikant Das said in an online address.

“At the same time, the MPC judged that the inflation outlook warrants an appropriate and timely response through resolute and calibrated steps to ensure that the second-round effects of supply side shocks on the economy are contained and long-term inflation expectations are kept firmly anchored,” he added.

The central bank also raised banks’ cash reserve ratio (CRR), or proportion of deposits that banks need to set aside with the RBI as cash, by 50 basis points to 4.50% effective from May 21.

Das said the CRR increase would withdraw liquidity of around 870 billion rupees ($11.4 billion) from the market.

Despite the tightening, the MPC also unanimously decided to retain an accommodative stance to support growth which it said was getting stronger but continues to face headwinds.

“Our monetary policy actions today – aimed at lowering inflation and anchoring inflation expectations – will strengthen and consolidate the medium-term growth prospects of the economy,” Das said.

India’s 10-year benchmark bond yield jumped to 7.42%, its highest since May 2019, right after the policy decision, while the rupee strengthened against the dollar to as much as 76.21.

The 10-year yield closed at 7.38% while the rupee ended at 76.4125 per dollar.

INFLATION RISKS

Das said the sharp acceleration in inflation in March to 7%, its highest in 17 months, was propelled in particular due to food inflation and due to the impact of unprecedented high global food prices.

He said food inflation pressures are likely to continue. Inflation has now been above the upper limit of RBI’s 2%-6% tolerance band for a third straight month. The RBI’s medium term inflation target is 4%.

“The biggest contribution to overall macroeconomic and financial stability as well as sustainable growth would come from our effort to maintain price stability,” Das said.

The repo rate, the rate at which banks borrow from the RBI, was cut to a record low in May 2020, when the economy was reeling from the onset of the pandemic, and the rate was held unchanged at that level at an MPC meeting last month.

Most analysts had expected rates to be raised at the next scheduled meeting of the six-member panel on June 6-8, and this week’s two-day meeting of the MPC caught financial markets unawares.

“We were already expecting more rate hikes than the consensus this year but the repo rate now looks set to rise beyond the 5.00% we had pencilled in for end-2022. We now think it will rise to 5.65% this year,” said Shilan Shah, senior India economist at Capital Economics.

Several traders said the RBI probably wanted to act ahead of the conclusion of a U.S. Federal Reserve meeting later in the global day. Many analysts expect the Fed to raise rates by 50 basis points.

($1 = 76.3363 Indian rupees)

Source: Investing.com

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