Despite smaller rate hike, bond market sees no let-up in RBI tightening

RBI may have moderated rate hike, but vigilant tone suggests defence of rupee

Reserve Bank of India (RBI) Deputy Governor Michael Patra on Wednesday said the central bank moderating the size of rate hikes was a fundamental guidance given to the markets. The RBI’s Monetary Policy Committee (MPC) announced a 35-basis point increase in the repo rate to 6.25 per cent on Wednesday.

Before Wednesday’s move, the previous three rate hikes by the MPC were each of 50 basis points (bps). India’s sovereign bond market, however, seems to believe that a reduced tightening notwithstanding, the central bank’s rate hike cycle has some distance to go.

The 10-year bond yield rose past the psychologically significant 7.30 per cent mark on Wednesday before easing back to close at 7.27 per cent, two bps higher than the previous close. Bond prices and yields move inversely.

Tellingly, yields on shorter-tenure bonds, which are extremely sensitive to interest-rate expectations, rose much more than the 10-year bond yield on Wednesday. The yield on the one-year paper jumped 11 bps while that on the five-year bond rose 6 bps.

HDFC Bank’s treasury research team sees the 10-year yield in the range 7.25-7.35 per cent over the near term.

The MPC’s repo rate hike may have been exactly in line with the bond market’s expectations, but RBI Governor Shaktikanta Das’ repeated emphasis on the persistence of core inflation (headline inflation minus food and fuel inflation) at elevated levels dampened hopes of the central bank ending rate hikes.

In a note released after the MPC’s statement, Nomura’s economists predicted a 25-basis point rate hike in February.

Das said the main risk was that core inflation remained sticky and elevated and that overall, the consumer price index momentum remained high.

“Core inflation is only likely to come down from 6 per cent levels around April-June of next year. Going by the policy today (Wednesday) a rate hike in February is a live option,” said Naveen Singh, head of trading, ICICI Securities Primary Dealership.

Some analysts are of the view that by moderating the pace of rate hikes but continuing to sound vigilant on inflation, the RBI was looking to protect the rupee.

At a time when the Fed is seen continuing with rate hikes, anticipating the RBI to end rate hikes — and thereby narrowing the rate differential between India and the US — could hurt the rupee by emboldening speculation against the domestic currency.

“Today’s policy announcement does provide a soft support for the rupee ahead of the Fed meeting next week and can be viewed perhaps as an attempt by the RBI to continue aligning itself with the still hawkish G7 central banks,” HDFC Bank’s treasury desk wrote.

The rupee strengthened 14 paise to close at Rs 82.48 to the dollar on Wednesday.

A key factor that had led to market expectations of a less aggressive RBI was the decline in GDP growth in July-September, which would make the case for slower rate hikes. The yield on the 10-year benchmark paper had fallen to a two-and-a-half month low of 7.21 per cent on December 1.