Singapore-based DBS Group said it expects a further rate cut in April after the RBI's decision to cut key repo rate by 25 bps on Thursday.
The Reserve Bank of India's policy panel surprisingly reduced the repo rate, looking past the stickiness in core inflation and impact of an expansionary fiscal policy, said DBS in a commentary.
DBS had expected a pause on rates.
The wide cushion on real rates vs the region also provided the RBI with sufficient justification, added DBS in the commentary on the RBI cut of the repurchase rate by 25 bps to 6.25 per cent.
They noted RBI Governor Shaktikanta Das' remarks that "there is room to cut", saying it suggests "this is not a one and done easing".
A sharp revision in the inflation outlook and limited spillover seen from a slippage in fiscal targets, paves the way for a shallow rate-cut cycle, said the DBS duo.
"On the markets, we retain our call for further bond-curve steepening," said Rao and Leow in their commentary.
Yields on the longer-end of the curve will be underpinned by the Centre's sizeable borrowing programme, while demand from domestic banks is likely to remain modest (given excess SLR holdings and recent cuts).
Short-tenor papers might benefit from a dovish central bank policy.
Better liquidity conditions and the prospect of another rate cut (by 2Q) should drive the 3-month rupee reference rate lower in the coming months.
The current spread between the 3-month rate and the overnight repo rate is wide, hovering above 100 bps despite signs of improvement in banking system liquidity, the duo pointed out.
This is not sustainable. Less strict rules on foreign portfolio investments and a less hawkish US Federal Reserve should drive foreign funds to rupee assets. In any case, look for the 3-month Mibor to fall below 7 per cent as the seasonal 1Q liquidity tightness fades.
For the rupee, a combination of broader dollar strength, arising from stronger incoming data from the US (which strengthens our expectations of further rates hikes) and domestically, higher political premia are likely to keep the currency under pressure, they said in the DBS commentary.
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