For the second straight meeting of the Monetary Policy Committee, members unanimously voted to keep interest rates unchanged, with the repo rate, the rate at which it lends to banks, at 6.5%.
While the action was on expected lines and the Governor listed out uncertainties from geopolitical developments to El Nino, there’s comfort emerging that the interest rate cycle has peaked and the next move could be a cut in policy rates – whenever it happens.
“With the policy repo rate at 6.50% and full-year projected inflation for FY24 at just a little above 5%, the real policy rate continues to be positive,” Das said.
Price Stability Mandate
Inflation targeting as a monetary policy objective emerged in 2016 after years of price increases led to negative real interest rates, spawning financial instability when savers began to chase gold and real estate to ensure the value of their savings doesn’t erode.
While the law mandates the consumer price index (CPI) target of 4%, with a 2 percentage point buffer on either side, policymakers were comfortable if it was within the ceiling of 6%. But Governor Das is working to wean people away from that mindset. Inflation being within the tolerance band itself was “not good enough,” said Das.
That may be the typical conservatism of a central banker who wants to ensure that the market doesn’t run ahead of itself. His tone of caution provides the RBI with the ability to react to data. But factors point to the end of a rate increase cycle, despite Canadian and Australian central banks resuming rate increases after a brief pause.
Cycle Peaked?
“This second straight pause suggests to us that the RBI has reached this cycle’s peak repo rate,” said Rahul Bajoria, economist at Barclays.
It may not be just the peak of a rate hike cycle, but stars are aligning for lowering the cost of funds.
The intensity of inflation that caught global central banks unawares last year is cooling off. Commodity prices that were on a tear are down as demand begins to taper on the high cost of funds. The fizzling out of China’s reopening provides further confidence that demand-driven inflation may not materialise.
RBI’s confidence that domestic farm prices could remain under check, barring adverse effects of El Nino, has led to the belief that inflation could only slide toward its target. Its projection of inflation at 4.5% for FY25, made in the Monetary Policy Report in April could be brought down further.
Above all, the Governor is drawing comfort from the results of monetary tightening on the common man.
Positive Real Rates
Real rates, the difference between inflation and policy rate, are positive at about 150 basis points. With inflation projected to ease, it could only get better. Inflation expectations of households for three months-to-one year-ahead horizon have moderated by 60 to 70 basis points since September 2022.
“This would indicate that anchoring of expectations is underway and that our monetary policy actions are yielding the desired results,” said Das.
Monetary policy cycles don’t turn abruptly, especially when the rates have to ease unless there are financial stability issues such as the Global Financial Crisis, or the Covid pandemic.
Ceteris paribus, investors can prepare for a rate cut cycle, even if it is a shallow one, by early next year. Das may insist on the 4% target, but it need not get there for him to act.
“We are looking at inflation aligning with the target, not with inflation at target,” said deputy governor Michael Patra.