RBI cuts policy rate despite concerns over inflation

India's RBI announced a 25bp cut in the policy rate (repo rate) to 7.25% during its bi-monthly meeting held today. This was widely expected by the market. 

While announcing this third cut for 2015, the RBI flagged the possibility of rising inflation. In fact, the RBI has revised upward its CPI expectation for January 2016 to 6% yoy from 5.8% yoy previously. 

Thus, in the event of the RBI staying on hold until Jan 2016, the real policy rate would tumble to 1.25% - below the lower bound of the central bank's official target range of real policy rate of 1.5-2% - unless the RBI decides to reverse its monetary policy stance toward the end of the year and raises rates as its expectations regarding the inflation trajectory materialise.

"Although we previously acknowledged the rising risk of a rate cut, we were concerned about inflationary tailwinds. We believe that not only would inflation perk up in May (data to be released on 12 June), it would eventually inch closer to the RBI's January 2016 headline CPI target of 6%." notes Societe Generale