With retail inflation showing signs of softening and the US Fed moderating the pace of increase in its benchmark interest rate, the Reserve Bank is likely to settle for a smaller 25 basis points repo rate hike in its forthcoming bi-monthly monetary policy due later this week.
In its December monetary policy review, the central bank had raised the key benchmark interest rate (repo) by 35 basis points (bps) after delivering three back-to-back increases of 50 bps.
Since May last year, the Reserve Bank has increased the short-term lending rate by 225 basis points to contain inflation, mostly driven by external factors, especially global supply chain disruption following the Russia-Ukraine war outbreak.
RBI's rate-setting panel - Monetary Policy Committee (MPC) - will start its three-day deliberations on the next set of monetary policy on Monday. The decision will be announced on February 8.
Kotak Institutional Equities in a report said the global inflation environment is gradually turning benign although inflation is still well above every central bank's target. Inflation will likely moderate further in the next few months, leading to the end of the rate hiking cycle by first half of 2023 and possible rate cuts in late-2023/early-2024.
Also watch: Don't see systemic risk to financial system: Uday Kotak on Adani-Hindenburg row
"However, given large global uncertainties, central banks' levers for supporting growth through monetary easing remain limited, thereby risking higher rates for an extended period.
"We expect the RBI MPC to hike policy rate by 25 bps to 6.5 per cent, followed by a prolonged wait-and-watch approach, as it assesses the lagged impact of monetary tightening on growth and inflation," it said.
The RBI has been tasked to ensure that retail inflation remains at 4 per cent with a margin of 2 per cent. However, it failed to keep the inflation rate below six per cent for three consecutive quarters beginning January 2022.
However, the retail inflation based on the Consumer Price Index (CPI) has shown signs of moderation in November and December as it fell below the RBI's upper tolerance level of 6 per cent.