The market expects another interest rate cut because inflation remains favorable

Mumbai: Indian economists and bond market experts are pricing in a further quarter-percentage-point cut in policy rates, lowering end-rate expectations in the current easing cycle, after the central bank looked past a sharply retreating rupee to deliver a rate cut on Friday. A sharp downward revision in the central bank’s FY26 inflation forecast, and Reserve Bank of India (RBI) Governor Sanjay Malhotra’s comments indicating that the policy rate will remain low rather than high, have fueled expectations of another cut in the policy repo rate, which now stands at 5.25%. A further cut would take the terminal repo rate to 5%. However, economists differ on the timing of the next cut: February or April.

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

Governor Malhotra also said on Friday that “while growth remains resilient, it is expected to moderate somewhat”.

Nominal GDP, which ignores the impact of the GDP deflator, remains somewhat cautious.

“Nominal GDP growth above 7% would indicate the output gap is positive, but low GDP deflators amplify real GDP growth and alternative signals such as core inflation, the credit gap, nominal GDP growth, the current account deficit and tax collections do not indicate an economy operating above potential,” Nomura said in a report.

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

A sharp downward revision of the inflation forecast by 120 and 110 basis points for the third and fourth quarters respectively reinforced expectations of a further rate cut.

The RBI now forecasts inflation of 0.6% in the December quarter, compared to 1.8% in October in the third quarter. In the fourth quarter, RBI expects a CPI of 2.9%, compared to the previous forecast of 4%. For the full year FY26, RBI cut its CPI forecast to 2% from 2.6%.

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