RBI surprising the street with 25 basis points hike in repo rate

It was surely a case of   surprising the street with a front-ended 25 basis points hike in repo rate in Aug policy. Less than 2 months after its last rate hike in June, the Monetary Policy Committee (MPC) hiked repo rates by another 25 basis points to 6.50% as food and fuel inflation threaten the price stability. Nifty closed marginally lower on Wednesday despite the rate hike by the RBI. While banks and auto companies (rate sensitives) did take a hit on the 25 basis points repo rate hike, markets are now betting on the rate hikes for the full year having entirely been front-ended. Worst may be over for markets.

Tyre companies were in the limelight on the back of falling rubber prices and upbeat demand from the auto sector. Now the evidence is out in the form of numbers. Apollo Tyres reports a 200% rise in net profits at Rs.252 crore in Q1. The sharp rise in profits was driven by robust sales in India and in Europe. Net sales were sharply higher by 20%. Tyre costs have benefited substantially from lower rubber prices in the recent past. The government already has a favourable policy towards Indian radials and that also added to the sweet spot that the tyre sector finds itself in.

It was a day when the rupee strengthened and the bond yields faltered. INR strengthened by over 17 basis points to 68.43/$ in the aftermath of rate hike. With the benchmark yields nearly 100 bps below the recent peak, the rate hike appears to have absorbed most of the worries of the narrowing real interest rate gap in the Indian economy. 10-year bond yields retreated by 10 basis points to 7.70% well below the recent 8% peak. The 25 bps hike in rates combined with a neutral guidance by MPC indicated that the upside risk to rates may be over for now. It led bond yields to retreat post the policy.

Finally, LIC may have got hold of a banking license through the acquisition of IDBI Bank. Cabinet approved LIC’s acquisition of 51% stake in IDBI Bank, rather than a small stake sale. This will enable LIC to take full management control over IDBI Bank and also permit the insurer to enter the Indian banking industry via this acquisition. It will be beneficial to IDBI Bank shareholders. In fact, there was little justification for the government to retail any control over the bank and the recent decision by the Cabinet is the step in the right direction. Of course, one can still debate the merits of the takeover decision.

In stark contrast to the RBI intent to front-end rate hikes, the Fed left the interest rates unchanged but maintained strong GDP growth guidance. Fed has cautioned that this pause may be temporary as the rates are likely to rise in tandem with higher economic growth. The target Fed rate remains unchanged as before. US 10-year bond yields trade above the psychological 3% mark. More than the guidance on Fed rates, the US bond markets were spooked by the aggressive borrowing program announced by Trump which is likely to push rates up further in the US. If the US growth momentum continues and the Trump government persists with its aggressive borrowing program then the Fed may have little choice but to resort to quicker rate hikes in the forthcoming Fed policies.

Oil took a hit on Tuesday but the impact was more from demand expectations rather than supply expectations. Brent crude weakened and got closer to $73/bbl on global slowdown fears. Even if you leave US stockpiles, the oil market is worried that a full-fledged trade war could lead to a reduction in global trade and lower output growth, impacting demand for oil negatively. Hence the big challenge for oil right now is not about supplies and stockpiles at all. The real worry is all about whether there will be sufficient demand for oil or it would be constricted by the demand insufficiency factors.