India's surprise rate hike spurs bets on more sharp increases

MUMBAI (BLOOMBERG) - After being lulled into complacency as recently as February that India's central bank will not tighten policy any time soon, investors have swung the other way and are factoring in sharp increases by the monetary authority that is grappling with surging inflation much like its counterparts globally.

Nomura Holdings expects the central bank to raise its benchmark repo rate to 5.75 per cent by end-December from 5 per cent earlier. Barclays said the central bank's aggressive tightening on Wednesday (May 4) has fuelled expectations of a 75-point increase in the June policy.

The Reserve Bank of India (RBI) stunned the markets on Wednesday with its 40-basis point rate increase and a move to suck out billions from the banking system. That was a remarkable U-turn from February when it announced an ultra-dovish policy, highlighting a relaxed stance towards inflationary pressures at home and United States tightening abroad.

"The markets, mollycoddled by previous comments and supporting the RBI's earlier stance, will feel cheated," said Mr Arvind Chari, chief investment officer at Quant Advisors. in Mumbai. "The 'shock and awe' was visible with bond yields rising sharply, especially at the shorter end of the curve."

Yields on the benchmark 10-year bond jumped as much as 30 basis points on Wednesday to 7.42 per cent, the highest since 2019, while the shorter four-year yield saw a nearly 50-basis point jump. Yields extended gains on Thursday.

The sharp repricing in swaps now reflects the overnight rate moving 110 to 115 basis points higher over a five-week period until the next June 8 decision, instead of an eight-month transition over four meetings earlier, according to Barclays Bank.

Later Wednesday, the US Federal Reserve raised its key rate by 50 basis points as expected, but provided some relief to emerging markets as it talked down the possibility of super-sized hikes.

Back home, the key takeaway for most investors was the RBI acknowledging inflation risks rather belatedly and that it was well behind the curve and market pricing when it came to policy normalisation.