India raises rate to pre-pandemic level to fight inflation

The Reserve Bank of India's key policy repo rate was raised by 50 basis points on Friday, the third increase in the current cycle to cool stubbornly high inflation that has remained above the central bank's tolerance band for six straight months.

With June retail inflation hitting 7%, economists polled by Reuters had expected the third rate hike in four months, but views were widely split between a 25 bps to a 50 bps increase.

The monetary policy committee (MPC) raised the key lending rate or the repo rate to 5.40%.

"Inflation is projected to remain above the upper tolerance level of 6% through the first three quarters of 2022-23, entailing the risk of destabilising inflation expectations and triggering second round effects," the MPC said in its statement.

The Standing Deposit Facility rate and the Marginal Standing Facility Rate were adjusted higher by the same quantum to 5.15% and 5.65%, respectively.

The RBI caught markets off guard with a 40 bps hike at an unscheduled meeting in May, followed by a 50 bps increase in June, but prices have shown little sign of cooling off yet.

With inflation staying elevated more rate hikes are all but inevitable in coming months, economists say. 

"The RBI today raised the repo rate by 50 bps to 5.40% as we had anticipated, and struck a relatively hawkish tone despite inflation surprising to the downside in recent months," said Shilan Shah, senior India economist at Capital Economics.

"It's clear that the tightening cycle still has legs and we expect another 100 bps of hikes by early 2023," he added.

Spiking pricesfor food and fuel have hammered consumer spending and darkened the near-term outlook for India's economic growth, which slowed to the lowest in a year in the first three months of 2022.

The MPC retained its GDP growth projection for 2022/23 at 7.2% while its inflation forecast remained unchanged at 6.7%.

"With growth momentum expected to be resilient despite headwinds from the external sector, monetary policy should persevere further in its stance of withdrawal of accommodation to ensure that inflation moves close to the target of 4% over the medium term, while supporting growth," Governor Shaktikanta Das said in his address.

Das said the decision to increase rates was a unanimous one.

The benchmark 10-year bond yield climbed after the RBI's decision and was at 7.25% at 0600 GMT. It had declined to 7.1073% earlier on Friday after ending at 7.1566% on Thursday.

The partially convertible rupee firmed slightly to 79.0675 per dollar, from 79.16 prior to the policy decision. The local unit had closed at 79.4650 in the previous session.

Disclaimer: The headline has been modified.