The RBI monetary policy committee meets this week, and markets will keenly watch for the Governor’s tone as well as language to gauge the central bank’s direction of travel on policy. The macro environment has undergone significant changes since the RBI monetary policy committee’s (MPC) August policy meeting, with global oil prices rising past $100bl, and US Fed kickstarting their rate hike cycle. A gradual broadening of domestic price pressures is likely to keep headline inflation high and narrow the real rate buffer significantly (see preview note). The headline is expected to run-up towards 6% in the Dec quarter, partially due to a low base, but showing incipient signs of broadening out.
We expect the MPC to vote for a 25bp rate hike to 5.5%, as policymakers shift gears after an extended pause since January. A change in stance from ‘neutral’ to ‘withdrawal of accommodation’ in Oct or Dec will also underscore the hawkish intent. The key question for markets is whether the hike is a recalibration following last year's cuts or marks the start of a longer hike cycle. We expect one more hike within 4Q26, though the odds of additional hikes have risen as oil prices stay stubbornly high and weather remains unfavourable.
Onshore financial markets are feeling the heat from global developments, with FPIs withdrawing ~$6.3bn from the debt and equity markets in Sep-Oct26, pushing USDINR back above 96.00. While the FX intervention response has been strong, the central bank will prefer to time dollar sales to rationalise the use of the reserves buffer and prevent widening the ballooned short FX forward book. Meanwhile, surplus in the banking liquidity attracted two overnight VRRR auctions on Monday, helping to absorb INR 2.1trn, while OMOs and sell/buy swaps are the other preferred tools. The likelihood of a CRR hike was played down in the past. As such, the RBI's inflation mandate has reinforced the push to drain excess liquidity and align the overnight rates to the repo to allow for effective monetary transmission. With euro jitters feeding into the dollar index, we expect USDINR to stay biased for upside this week, while 10Y yield holds above 7.0%.
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