MUFG Expects RBI to Hold at 5.25%, Sees Two Rate Hikes by February

The primary transmission of the Middle East conflict into Indian policy is through oil. As a major crude importer, India experiences a rapid pass-through of higher energy costs into inflation and the trade balance, simultaneously putting pressure on the rupee as rising US yields lure capital from emerging markets. Consequently, the RBI's comments on currency defence and inflation projections carry as much weight as the rate decision itself. According to MUFG, because markets are already pricing in more tightening than the bank expects, a hold with an only moderately dovish signal might benefit Indian government bonds. Conversely, moving away from the neutral stance or issuing explicit warnings about oil-driven inflation would have the opposite effect and could provide some rupee support.

The Reserve Bank of India is widely expected to hold rates today, but MUFG believes this is merely a pause ahead of a tightening cycle fuelled by oil, liquidity conditions and a weaker rupee.

Key points:

• The Reserve Bank of India's policy decision is due today at 10:00 am India time (04:30 GMT, 00:30 ET)
• MUFG predicts the repo rate will stay at 5.25% but views the hold as temporary
• The bank points to higher oil prices, weather-related risks, strong domestic demand and plentiful rupee liquidity as factors pushing inflation up
• Rising US yields are pressuring the rupee, but MUFG states the RBI has sufficient reserves to support the currency
• MUFG anticipates 25 bp increases in December and February, with a possibility of 75 bp in total, which is below what markets are pricing

India's central bank is widely expected to leave the benchmark rate unchanged at its announcement today, though MUFG argues the pause will be short-lived due to mounting inflation risks.

The six-member Monetary Policy Committee will deliver its decision at 10:00 am India time (04:30 GMT, 00:30 ET), concluding a three-day meeting. Since February, the repo rate has been unchanged at 5.25%, and the RBI's August review kept a neutral policy tone.

For today's meeting, MUFG predicts a hold. But the bank says recent developments have reinforced its belief that the RBI is nearing the beginning of a gradual tightening cycle. Elevated oil prices and weather-related risks have increased upside inflation pressure. According to the bank, robust domestic demand and ample banking system liquidity will likely keep underlying price pressures high through 2027.

Global factors add to the difficulties. Higher US Treasury yields have pressured the rupee by attracting capital to higher US returns, though MUFG points out that the RBI has ample reserves to shield the currency from excessive depreciation.

MUFG projects 25 bp hikes at the RBI's December and February meetings, with a chance that the cycle reaches 75 bp in total. Even that amount, it states, would be less aggressive than what rates markets currently anticipate for the overall cycle.

Beyond the rate decision itself, investors are watching for any change in the RBI's neutral stance, revisions to its inflation and growth forecasts given higher energy costs, and comments on liquidity and the rupee. If policymakers indicate agreement with MUFG's perspective on rising inflation risks, it would boost expectations for a hike at the next meeting, which ends on 4 December.