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“The markets are still coming to terms with RBI’s bombshell last Friday. The SENSEX plunged 2.3%, the 10Y government bond yield collapsed over 13bp to 8.03%, and USD-INR shot above the 74.00 at one point before paring back gains to close around 73.77,” note Commerzbank analysts  and add: “At today’s open, equities are modestly higher, while bond yields and INR remain under pressure.”  

Key quotes

Why was it a big surprise?  This was because the 3-month overnight index swaps (OIS) market was fully pricing in 50bp worth of rate hikes in the next three months. A 25bp in October was seen as the bare minimum followed by another hike in the final meeting for this year on 5-December. Instead, RBI was unafraid to go against market expectations and accept the fallout. This was seemingly done to control the narrative on rate hikes.”

“The six-member monetary policy committee voted 5-1 for no change with one voting for a 25bp hike. RBI also shifted the official policy stance to “calibrated tightening” from neutral. The vote split was 5-1 in favour of the hawkish bias with one member opting for no change. RBI Governor Patel reiterated this point in the press conference by noting that this essentially means “a rate cut is off the table for now”. This reinforced RBI’s positive growth outlook, unchanged at 7.4% for FY2018-19. RBI sees three key downside risks to growth, they are 1) ongoing trade tensions which will hurt both investor sentiment and investment decisions; 2) high oil prices; and 3) tighter financial conditions both domestically and globally e.g. last week’s spike in US 10Y government bond yield by 17bp to 3.23%.”

What was the justification?  It was because of a more subdued inflation backdrop near term before picking up again in Q1 2019. RBI lowered the inflation outlook to 4.3% for FY2018-19 from 4.7% previously. It sees 4.3% in the first half of the current fiscal year, 4.2% in the second half of the fiscal year and picking up to 4.8% in Q2 2018.”