Monetary Policy Committee moving towards interest rate hike

The RBI's monetary policy committee (MPC) had unanimously voted for a status quo on the policy rate earlier this month even as one member of the panel felt a 25-basis-point increase in the repo rate was needed to tame inflation.

RBI Governor Urjit Patel told the MPC that "the outlook for inflation calls for close vigilance" and there is room for banks to further cut interest rates.

During its April 6 monetary policy meeting, the RBI kept its key policy rate unchanged citing upside risk to inflation while increasing the reverse repo rate by 25 basis point to drain out excess liquidity from the system.

Although committe member and RBI Executive Director Michael Patra favoured an increase in the repo rate by 25 basis points as a pre-emptive move to check inflationary pressures, at the end the six-member MPC unanimously made a decision to maintain status quo. "On balance, however, I vote for holding the policy rate unchanged in this bi-monthly meeting", he said adding he would wait for more data. "It will also obviate the need for back-loaded policy action later when inflation is unacceptably high and entrenched", he stated.

"The lower neutral rate implies that, if the MPC were to lift rates at some stage, the tightening path probably would be limited and gradual".

However, some do not rule out the possibility of a rate hike later.

"I do not believe the MPC is necessarily obliged to delay any policy moves until we have certainty over the exact shape of Brexit and its long-run effects on the economy".

In a speech on Friday, external Bank of England MPC member Saunders suspected that there will be steady growth over the next 1-2 years with above-target inflation, stronger exports and a pick-up in business investment.

Increase in house rent allowance as recommended by the seventh pay commission can push up the RBI's baseline inflation trajectory by an estimated 100-150 basis points over a period of 12-18 months.

"Our focus on meeting the medium-term inflation target should remain laser sharp in light of such risks", Ghate said. However, in all probability, inflation will significantly undershoot the 5% target set for Q4 of 2016-17.

According to RBI's reading the inflation trajectory through 2017-18 appears uneven and is challenged by upside risks and unfavorable base effects towards the second half of the year.

  • Zachary Reyes