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Fed provides inspiration to RBI

Mumbai, Aug. 9: The decision of the US Federal Reserve to leave key interest rates untouched has strengthened the belief among bankers and the markets that the Reserve Bank of India (RBI) may also choose to do the same in October when it undertakes a review of the monetary policy.

India’s central bank has so far raised the reverse repo rate on three occasions this year with the last increase done in July.

The RBI, in its first quarter review, increased both the reverse repo and the repo rates by a quarter of a percentage point each to 6 per cent and 7 per cent, respectively, to counter inflation. The reverse repo is an instrument through which the apex bank mops up surplus liquidity from the system.

In June, the Reserve Bank had, in a move which took everybody by surprise, raised both the reverse repo and repo to 5.75 per cent and 6.75 per cent, respectively.

“There was a feeling among the bond markets and banks after last month’s hike that the RBI may go into pause mode till the next calendar year. The US Federal Reserve's move has further strengthened that view,” says a senior official from a leading private sector bank.

In June this year, RBI governor Yaga Venugopal Reddy justified the 25-basis-point reverse repo rate hike by saying that interest rates were hardening globally and India could not be “out of sync” with the monetary developments in the world.

“Several central banks have raised interest rates globally. Our monetary policy cannot be out of sync with the policies of major economies... We are now in sync with global policies,” he had said then.

On Tuesday, the Federal Open Market Committee (FOMC), which is the US central bank’s policy setting body, kept the federal funds rate at 5.25 per cent, thereby breaking an interest rate tightening cycle which had commenced in 2004. The US Federal Reserve had successively hiked interest rates on 17 occasions. Its move to keep interest rates unchanged came from a slowing US economy.

The Bank of Japan (BoJ) is also scheduled to meet on August 11 to take a call on interest rates. Analysts expect the Japanese central bank to keep its monetary policy unchanged as well. Last month, the BoJ had raised interest rates for the first time in six years.

Although there is an overall optimism over interest rates remaining steady from here on for the next few months, there are worries. With crude oil prices inching to all-time highs, inflation still remains a concern. The anxiety over inflation was voiced by the US Federal Reserve when it said, “The committee judges that some inflation risks remain.”

This has led to a feeling among many that the US central bank is not yet done with tightening interest rates, though it is largely felt that a hike may come only early next year.

The US Federal Reserve's move today had its impact on the financial markets where bond prices rallied. Equity markets rose on optimism that inflows from foreign institutional investors (FIIs) would continue to pour into emerging markets like India.

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