Bond Street sees one cut, then status quo

Yield on 10-year benchmark rose 7 bps, indicating expectations of sizeable rate cuts have significantly come down

Bond market expectations have tempered significantly after the Reserve Bank of India (RBI) decided to hold key rates in its monetary policy review.

The market now believes there could be one more rate cut of 25 basis points (bps) in June, after which the central bank might hold on for some time.

“Marrying RBI's preference to hold real rates at 1.5-2 per cent to our forecast of 5.5 per cent inflation over the next two years suggests a repo rate of 7.25 per cent, which implies a final 25 bps rate cut. We expect this to come through in June and for RBI to go on hold thereafter,” said Pranjul Bhandari, chief India economist at HSBC, in a note to clients on Tuesday.

The market reacted to RBI’s decision on status quo with the yield on the 10-year benchmark government bond up seven bps on Tuesday, ending at 7.79 per cent. (WALKING THE INFLATION TIGHTROPE)

“Yields went up as RBI did not cut the repo rate. The CPI (consumer price index)-based inflation data for March, to be released later this month, is expected on the higher side. We might see just one more rate cut of 25 bps in 2015,” said the head of treasury of a large public sector bank.

Since the beginning of the calendar year, the central bank has already done two out-of-policy cuts, of 25 bps each. Currently, the repo rate is 7.50 per cent. RBI said it was awaiting transmission by banks of its front-loaded rate reductions in January and February into their lending rates. The country’s largest bank, State Bank of India, responded on Tuesday evening by cutting the base rate by 15 bps.

“Although RBI appears to still be in easing mode, the timing of any future action is contingent on several factors. With growth in the initial stages of a cyclical recovery, investments held back largely due to non-monetary factors, inflation showing signs of stabilising around 5-5.5 per cent and RBI’s medium-term target of moderating CPI inflation to four per cent, we believe policy rates are largely close to neutral,” said Sonal Varma and Aman Mohunta of Nomura in a note to clients.

Nomura expects one final 25 bps rate cut before RBI alters its stance to neutral.

The policy statement said in 2015 so far, the inflation path had evolved along the projected one, after a sizable undershoot of the January 2015 target.

“CPI inflation is projected at its current levels in the first quarter of 2015-16, moderating thereafter to around four per cent by August but firming up to reach 5.8 per cent by the end of the year,” it said.

The accommodative stance will be maintained, but monetary policy action will be conditioned by incoming data.

Developments in sectoral prices, especially those of food, will be monitored, as will the effects of recent weather disturbances and the likely strength of the monsoon, as the central bank stays vigilant to any threats to the easing of inflation.

RBI said it would look to a continuation and even acceleration of policy efforts to unclog the supply response, so as to make available key inputs such as power and land.

Finally, it will watch for signs of normalisation of US monetary policy, though it anticipates India is better buffered against likely volatility than in the past.

RBI plans to contain CPI-based inflation below six per cent by January 2016. This had risen to 5.37 per cent in February, from 5.19 per cent the previous month, mainly because of high food prices.