US Fed hikes rate by 0.75% again; will RBI follow suit?

As inflation continues to rise across the world due to the ongoing Russia-Ukraine war which led to the surge in international crude prices, the US Federal Reserve hiked interest rates by 75 basis points (bps) for the second straight month on Wednesday. With this, the cumulative rate increase in the last two months stood at 150 bps, which is the highest since the early 1980s. Central banks in Australia, the United Kingdom, Europe, and Canada have also raised their rates to combat rising costs. Will the Reserve Bank of India (RBI) follow suit?

The Federal Reserve on Wednesday raised the official interest rate by 0.75% after a similar hike in June, coupled with earlier actions in March and May, taking its benchmark rate to a range of 2.25% to 2.5%. Further to the announcement, Fed raised the target range for the federal funds rate between 3%-3.5%, while indicating that pace of rate hike would be slower going ahead.

“Interest rate guidance of 3% to 3.5% leaves scope for either one unusually large increase in September policy meeting or a step by step increase of the same magnitude which suggests this hike in rate cycle may not last for long. This reading was validated by US10Yr bond yield which didn’t budge from levels of 2.79% and dollar index too cooling off from 107 levels post the policy announcement,” says Siddarth Bhamre, Head of Research, Religare Broking.

“Fed through its commentary has made markets believe that this interest rate upcycle may not last long contrary to what was estimated before. This may have positive implications on equities globally,” he adds.

Besides, the US central bank also affirmed its commitment to continue reducing its holdings of treasury securities, agency debt, and agency mortgage-backed securities for reducing the size of the Federal Reserve's balance sheet. The committee also aims to bring down to inflation at the rate of 2% over the longer run, which shoots up to a new 40-year high of 9.1% in June due to supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures in the backdrop of ongoing war in Ukraine.

Will RBI follow its global counterparts?

As the inflation pressure continues to hurt economic growth, the RBI monetary policy committee (MPC) is set to go for another round of rate hike in the upcoming meeting on August 5. However, recent supply side measures taken by the government to mitigate inflationary pressures suggests that rate hike may not be as steep.

The RBI has raised the rate by a cumulative 0.90% in May and June to ease inflationary pressure on the economy, with headline inflation continuously breaching the central bank’s upper target limit of 6%. The retail inflation, measured through Consumer Price Index (CPI), stood at 7.01% in June, which marks the sixth month when retail inflation remained above the tolerance band of 4-6% recommended by the RBI.

According to American brokerage firm BofA Securities, the central bank will announce a 0.35% hike in the key repo rate at its meeting next week. The agency expects MPC to retain its FY23 Consumer Price Inflation (CPI) and real GDP growth forecasts, at 6.7% and 7.2%, respectively.

"In our base case, we now see the RBI MPC hike policy repo rate by 0.35%, taking it to 5.25% (higher than pre-pandemic level), with stance change to calibrated tightening from the withdrawal of accommodation," the brokerage said in a report.

In the last policy meeting in June, RBI Governor Shaktikanta Das-led MPC hiked the repo rate by 50 basis points to 4.9% in order to contain spiralling inflation. The MPC decided to remain focused on the withdrawal of the "accommodative" policy stance to support the economy battered by Covid and the crisis that emerged due to the Russia-Ukraine war. Marginal standing facility rate was also hiked to 5.15% from 4.65%, respectively.