U.S. Fed delivers another rate hike; will RBI follow suit?

This year, the global economy has been rattled by inflation and geo-political tensions, which forced central banks across the world to move towards monetary policy tightening. The U.S. Federal Reserve, along with other central banks in Asia and Europe embarked on a rate hike programme to ease inflationary pressure on their economies.

Continuing its path of policy tightening, the U.S. central bank on Wednesday raised interest rate by 75 basis points (bps) for the third straight month in September to combat rising inflation, which surged to the highest in 40 years. The Federal Open Market Committee (FOMC) has raised official interest rates for the fifth time so far this year, taking the policy rate to 3-3.25%, and indicated that the rate will go past 4% to 4.4% by the end of the year. The latest interest rate projections by the Federal Reserve are higher than the previous projections, indicating that the central bank may continue its aggressive monetary tightening cycle in light of inflation trends.

According to market experts, the continued hike in U.S. interest rate may be risky for Indian equities, but it also provides an opportunity for foreign investors to diversify globally. “While rising Interest rates represent a headwind for Indian equities, our buoyant domestic demand scenario presents a sliver of hope for global investors looking to diversify globally. We remain constructive on Indian equities over the medium-term and continue to orient our portfolios around domestic cyclical which continue to look attractive to us from a medium-term perspective,” says Trideep Bhattacharya, CIO Equities, Edelweiss Mutual Fund.

RBI set to follow rate hike path

India also faces economic distress as a spike in commodity prices amid the Russia-Ukraine war and continued uptrend in inflation propelled the Reserve Bank to hike rates by 140 bps in three instances. Given that the headline CPI inflation remained above RBI’s upper threshold limit of 6%, the central bank is poised to continue its policy tightening approach this year. The market experts expect the RBI to raise the policy rate by another 50 bps to 5.9% in its policy meeting next week.

RBI Governor Shaktikanta Das-led six-member Monetary Policy Committee (MPC) is scheduled to meet during September 28-30, while the policy decision will be announced on September 30, the last date of the meeting. In the past three MPC meetings, the RBI has raised the repo rate, the interest rate at which the RBI lends to the commercial bank, by 140 bps in total since May this year, exceeding pre-pandemic levels of 5.15%.

Kotak Mahindra Bank expects the RBI to raise the repo rate to 5.75%-6.00% to support rupee and curb inflation. Another private lender YES Bank sees a 25 bps rate hike in the next two meetings, citing that slower global growth may prompt a softer pace of policy tightening.

Foreign brokerage Morgan Stanley has also revised its projections and expects a repo rate hike of 50 bps in the policy meeting next week. Earlier, it was expecting a 35 bps hike, but it revised upward citing sticky inflation.

Domestic brokerage firm ICICI Securities also expects the RBI to raise its policy rate by another 50 bps at its policy meeting at the end of this month, and a further 25 bps in December meeting to 6.15%. It also added that the cumulative impact of this year’s monetary tightening is likely to help bring headline CPI inflation back below 6% YoY in Nov’22 and beyond.

“Since the RBI targets headline CPI inflation, rather than core inflation, the moderation in the latter to below 6% YoY provides no relief. Food inflation remains a challenge, hence we expect the RBI to raise its policy rate by another 50bp at its policy meeting at the end of this month,” it said in the latest report.