RBI raises key lending rate

India's central bank yesterday unexpectedly raised its key lending rate by 25 basis points to eight per cent to rein in inflation, and analysts said more tightening could be expected if inflation continued to head towards double digits.

The Reserve Bank of India (RBI) said its first interest rate rise since March 2007 was to contain inflation expectations. The repo rate increase was announced after market hours and came outside a scheduled policy review. The reverse repo rate, the rate at which the central bank absorbs cash from the market, was left unchanged at six per cent. The cash reserve ratio (CRR), which has been the central bank's main policy tightening instrument over the past 18 months, was also left unchanged.

"We expect a reverse repo rate hike by 25 basis points as well, and another 75 basis point CRR hike by year-end," said Standard Chartered Bank economist Shuchita Mehta. "Inflation will remain high in the near term and may peak at about 9.5 to 10 per cent for the June period and then taper off. But it will stay above eight per cent through the year."

Data on Friday showed annual inflation at a three-year high of 8.24 per cent on May 24, and analysts said a rise in state-set fuel prices last week was expected to have pushed inflation above nine per cent in early June for the first time since August 1995. The repo rate is now at its highest since November 2002.

"There was always a possibility that there would be an interest rate increase, but perhaps most people may have expected this a bit further down the line than at this point in time," said Saumitra Chaudhuri, a member of the Prime Minister's Economic Advisory Council.

"To that extent, it may have been a surprise and the markets may now be looking at the possibility of subsequent round of rate increase sometime in Q2." The RBI's next scheduled policy review is on July 29.

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