Indian Central Bank could keep the policy rates at the same levels in the upcoming meeting but as the financial markets across the world have witnessed selling during the last two sessions, there could be a change in RBI's view about interest rates. It is also possible that the US Federal Reserve reduces interest rates earlier than September, considering the steep correction in stock markets across the world.

As per HDFC Bank's Treasury Research Desk, the central bank is expected to keep its policy rate unchanged at 6.5% at its upcoming meeting on 8th August. However, we do see an increasing possibility of either a change in stance to neutral (current stance at “withdrawal of accommodation”) or a dovish pivot in the RBI’s rhetoric in this policy. Although, it does remain a close call.

The Why?

Fed rate cut in September highly likely: For one, expectations of a rate cut by the Fed have increased significantly over the last few weeks, with calls of a 50bps rate cut as early as September and cumulative rate cuts of 115bps expected in 2024. While some of these expectations do seem overstretched at this stage, we do see a high chance of the Fed starting its rate cut cycle in September – delivering a cut of 25bps. This could have implications for the rupee and the RBI could start aligning its monetary policy with the global rate cycle to reduce any significant future policy deviations.

Monsoon progress has improved – bodes well for food inflation: Monsoon progress has been healthy with overall rainfall at +6% above the long period average. There are deviations across different regions – with the south recording excess rainfall and the North-west seeing deficient rainfall – but the distribution is expected to improve as the monsoon season progresses. Kharif sowing is also above last years’ level for major crops like rice and pulses. To this extent, food inflation risks seem broadly manageable and “not increasing in persistence” at this stage.

Core inflation has been low: Core inflation has been moderating for over 12 months now and while we could see some pick-up over the coming months (due to base effects, telecom tariff increases and some recovery in demand) it is still expected to average between 4-4.5% for FY25.

Liquidity balance has improved: Over the last month, system liquidity balances have moved into a surplus due to higher government spending and as the RBI absorbed dollar inflows -- injecting rupee liquidity -- to manage rupee volatility. While the RBI has regularly conducted VRRR operations to absorb surplus liquidity, the WACR (weighted average call rate) has averaged below the policy rate at 6.44% in July 2024 and the central bank seems to be a little bit more comfortable with some liquidity surpluses in the system.

Bottom-line is that the RBI could use this policy to set the stage for an eventual rate cut later this year. If this were to happen, we could see further down moves in bond yields with the 10-year yield moving towards 6.80% levels.