(Reuters) - The Reserve Bank of India (RBI) raised interest rates almost a month earlier than expected on Friday, and analysts said it would likely follow up the quarter point hike with another move on July 27, given concerns about inflation above 10 percent.
While a rate rise had been widely forecast, the timing came as a surprise to many economists and investors who had figured the RBI would refrain from tightening ahead of its scheduled quarterly review at the end of the month, given tight liquidity in the financial system.
"This is a timely step as demand-pull pressures are evident in both food and non-food price inflation," Rupa Rege Nitsure, chief economist, Bank of Baroda in Mumbai.
"There were also other indicators in the form of higher salary and wages in the corporate sector and higher house rent allocation component in consumer price index. I think this will be supplemented by another 25 bps rate hike in July policy."
The move, announced after the close of markets on Friday, comes a week after the government raised fuel prices, a measure it said would lift inflation by nearly one percentage point.
Analysts said Indian bond yields and swap rates may rise on Monday, although the increase may be muted since higher interest rates had been widely expected. The one year swap rate has risen 20 basis points since mid-June.
Rising prices have put the Congress party-led government under pressure, with opposition parties calling for a nationwide strike on Monday to protest against the fuel price increase. Inflation is expected to remain high in coming months.
"There has been some moderation in food price inflation, but the price index of food articles continues to increase," the RBI said. "More importantly, the prices of non-food manufactured goods and fuel items have accelerated in recent months," it said.
Canada and New Zealand raised interest rates in June as Asian and Pacific economies continued to outpace the recovery in the West, although central banks elsewhere in the region including Australia and South Korea have kept policy on hold because of concerns about the world economy and euro area debt worries.
India's domestically driven economy, however, has been growing at an accelerating pace, with growth forecast to hit roughly 8.5 percent in the fiscal year that ends in March 2011.
"India needs to focus on actual inflation pressures rather (than) a potential impact from euro area weakness, so today's decision shows policymakers have their eye on the ball," said Brian Jackson, senior emerging markets analyst at Royal Bank of Canada. "We expect more rate hikes in the months ahead."
SQUEEZE
The RBI said liquidity pressures resulting from telecoms auctions had made it inadvisable to raise interest rates earlier. Third-generation (3G) and broadband auctions raised $21.6 billion for New Delhi, sucking cash out of the financial system as firms paid for their wireless spectrum.
To address what it said was temporary and unexpected tight liquidity in the financial system, the RBI also on Friday extended an earlier measure to infuse cash into the system. Liquidity problems have eased in recent days.
Wholesale price index (WPI) inflation rose to 10.16 percent in May, exceeding expectations. Inflation in India had long been driven by high food prices, but prices had also been rising for manufactured goods and fuel items.
"It's a welcome move but probably RBI should have moved a little more aggressively -- not now, but earlier in April or May," said Jay Shankar, economist at Religare Capital in Mumbai.
The bank's main lending rate, or repo rate, rose to 5.50 percent from 5.25 percent, and the reverse repo rate, at which it absorbs excess cash from the banking system, to 4 percent, from 3.75 percent.
The yield on the 10-year benchmark bond closed at 7.56 percent ahead of the rate move, up four basis points from Thursday's close. The market had traded in a narrow range amid uncertainty over the timing of policy action. Many investors had expected a 50 basis point rate rise on July 27.
"Based on just this action, the market may react negatively on Monday. But this will be short-lived as the hike was largely expected," said Apurva Shah, head of research at Prabhudas Lilladher in Mumbai.
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