Market expects one more rate cut as inflation stays benign

Mumbai: Indian economists and bond-market experts are factoring in a further quarter percentage point reduction in the policy rates, lowering terminal rate expectations in the current cycle of easing after the central bank looked past a sharply retreating rupee to deliver a rate cut Friday.

A sharp downward revision in the central bank’s inflation forecast for FY26, and the Reserve Bank of India (RBI) governor Sanjay Malhotra’s remarks indicating that policy rates are more likely to remain low than high, have fuelled expectations of another reduction in the policy repo rate that now stands at 5.25%. A further reduction would take the terminal repo rate to 5%. Economists, however, differ on the timing of the next reduction- February or April.

Despite the robust headline GDP growth of 8.2%, market participants appear unconvinced about the underlying momentum. Their caution is driven by expectations that a GDP deflator, a widening current account deficit, and softer tax collections could weigh on headline growth.

Governor Malhotra also said Friday that “growth, while remaining resilient, is expected to soften somewhat.”

The nominal GDP, which strips out the impact of the GDP deflator, remains somewhat circumspect.

“Headline GDP growth of above 7% would suggest the output gap is positive, but low GDP deflators are amplifying real GDP growth and alternative signals like core inflation, the credit gap, nominal GDP growth, current account deficit, and tax collections do not suggest an economy running above potential,” Nomura said in a report.

Reduction in April?
Nomura’s base case anticipates a pause in the February policy meeting, followed by a 25-basis point rate cut in April. One basis point is a hundredth of a percentage point.

Indeed, a sharp downward revision of the inflation forecast by 120- and 110- basis points, respectively, for Q3 and Q4 reinforced expectations of a further rate cut.

The RBI now forecasts inflation of 0.6% in the December quarter from 1.8% in October in Q3. In Q4, RBI expects 2.9% CPI versus its previous forecast of 4%. For the full year FY26, RBI lowered its CPI forecast to 2% from 2.6%.

Excluding gold, core inflation had slowed to 2.6% in October, and the RBI estimated that precious metals alone had added about 50-basis points to headline inflation.