RBI hikes policy repo rate by 25 bps to 6.5% as inflation spikes

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) today announced a 25 basis point increase in the policy repo rate under the liquidity adjustment facility (LAF) to 6.5 per cent.

Consequently, the reverse repo rate under the LAF stands adjusted to 6.25 per cent, and the marginal standing facility (MSF) rate and the Bank Rate stands at 6.75 per cent.
The MPC said its decision is consistent with the neutral stance of monetary policy in and in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth.
RBI, however, has revised inflation projections for Q2 marginally downwards vis-àvis the June statement, while it kept projections for Q3 onwards broadly unchanged. The central bank cited several risks, including volatile crude oil prices, geopolitical tensions and supply disruptions.
Volatility in global financial markets also continues to impart uncertainty to the inflation outlook and a hardening of input price pressures on manufacturing in Q2 of 2018-19.
While there has been some relief on the monsoon front, RBI said, its regional distribution needs to be carefully monitored in the context of key CPI components such as paddy.
RBI’s survey of, household inflation expectations have risen significantly in the last two rounds, which could influence actual inflation outcomes in the months to come. However, if the recent softening of global commodity prices persists, it could mitigate some of the upward pressure on input costs, RBI said.
RBI also noted the possible impact of the hike in MSP on inflation in the next several months once the price support schemes are implemented. Finally, the staggered impact of HRA revision by state governments may push headline inflation up.
The MPC notes that domestic economic activity has continued to sustain momentum and the output gap has virtually closed. However, uncertainty around domestic inflation needs to be carefully monitored in the coming months. In addition, recent global developments raise some concerns.
Rising trade protectionism poses a grave risk to near-term and long-term global growth prospects by adversely impacting investment, disrupting global supply chains and hampering productivity. Geopolitical tensions and elevated oil prices continue to be the other sources of risk to global growth.
Consumer price inflation, measured by the year-on-year change in the CPI, rose from 4.9 per cent in May to 5 per cent in June, driven by an uptick in inflation in fuel and in items other than food and fuel even as food inflation remained muted due to lower than usual seasonal uptick in prices of fruits and vegetables in summer months. 
Adjusting for the estimated impact of the 7th central pay commission’s house rent allowances (HRA), headline inflation increased from 4.5 per cent in May to 4.6 per cent in June. Low inflation continued in cereals, meat, milk, oil, spices and non-alcoholic beverages, and pulses and sugar prices remained in deflation.
It is against this backdrop that the MPC decided to increase the policy repo rate by 25 basis points. The MPC has reiterated its commitment to achieving the medium-term target for headline inflation of 4 per cent on a durable basis.