MPC's larger-than-expected rate cut hints at pause to easing cycle: Icra's Nayar
The MPC likely chose to frontload rate action to squeeze the lags in transmission. With sufficient liquidity in the banking system at present, and the offer of further easing with the forthcoming CRR reduction, the rate cuts should percolate to deposit and lending rates quickly.
In an action-packed policy, the Monetary Policy Committee (MPC) unexpectedly delivered a number of surprises. These included a larger-than-expected immediate repo rate cut and a phased cash reserve ratio (CRR) reduction, by 50 basis points (bps) and 100 bps, respectively. Simultaneously, the stance was shifted back to neutral from accommodative, thereby suggesting a possible end to the rate easing cycle, after a rapid 100 bps reduction over three consecutive policy meetings. These measures were facilitated by the committee’s views on the growth-inflation dynamics, as well as the desire to induce some certainty around monetary policy actions, in an otherwise turbulent global economic environment.
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While expectations had been centred around a 25 bps rate cut in this policy meeting, the MPC surprised the markets with a 50 bps repo rate cut. The MPC likely chose to frontload rate action to squeeze the lags in transmission. With sufficient liquidity in the banking system at present, and the offer of further easing with the forthcoming CRR reduction, the rate cuts should percolate to deposit and lending rates quickly. A downward revision in interest rates on the small savings schemes for Q2FY26, which will be reviewed towards the end of this month by the government, would certainly aid this process.
The frontloading of the rate reduction was enabled by a downward revision in the MPC’s consumer price index (CPI)-based inflation projections, to below the mid-point of its medium-term target. The committee reduced its annual average CPI inflation for FY26 to 3.7% from the earlier 4.0%. This was chiefly led by a sharp moderation in the estimates for Q1 and Q2 of FY26 by 70 bps and 50 bps, respectively. We foresee a further dip in the CPI inflation from 3.2% in April 2025 to 3% in May 2025 and sub-3% in June 2025. Overall, inflation is expected to traverse from an average of a little under 3% in Q1 to above 4% in Q4FY26. Besides, the prints for H1FY27 are unlikely to be as benign given the unfavourable base effects for this period.
Simultaneously, an unexpected 100 bps CRR cut has been scheduled to take place in four tranches between September 2025 and November 2025 to boost liquidity to the tune of ₹2.5 trillion during the busy season. A second surprise here is the clear forward guidance around the provision of liquidity on an upfront basis, instead of waiting until the next policy meeting in August. This advance announcement is likely to have been motivated by the central bank’s strong preference for policy certainty.
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The frontloading of rate cuts along with the change in the policy stance appears to be a fairly strong signal of an end to the current easing cycle, given the clear messaging in the April 2025 meeting that the stance is meant to provide forward guidance on policy rates. This suggests that we are most likely looking at a pause in the next meeting in August 2025, unless inflation-growth numbers differ materially from what the MPC has set out.
Our own projections suggest that the CPI inflation will average at 3.5% in FY26, 20 bps lower than the MPC’s forecast, with the expectations of somewhat lower prints in Q3 and Q4FY26. Moreover, our GDP growth estimate for FY26, at 6.2%, is 30 bps lower than that of the MPC, which was kept unchanged from the April 2025 meeting.
Before today’s 50 bps cut was announced, we had expected an additional 75 bps of easing to be forthcoming before this cycle ended. The materialisation of a final 25 bps cut will have to be associated with a downward revision in either the MPC’s inflation or growth forecasts, or both. Consequently, this is likely to be pushed out to the October 2025 meeting, by when the Q1FY26 GDP print will be available, and the outturn of the monsoon would be behind us, and the impact of the same on the sustenance of low food inflation beyond FY26 would be somewhat clearer.
While the bond markets reacted favourably to the policy decisions at the outset, the change in stance subsequently pushed up yields. We believe that a cumulative cut of 50 bps was largely priced in, and the only surprise was the frontloading. Looking ahead, we expect the 10-year yield to trade between 6.20% and 6.40% in the remainder of the calendar year, unless expectations crystallise around another rate cut. In that case, the 10-year yield could ease to as low as 6.0%.
Aditi Nayar is chief economist and head, research and outreach, Icra.
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