Why do the effects of the effects rise even to RBI pre-loaded rate cuts? Explain

The power of a central bank is determined by the ability of the financial sector to convey policy changes. Monetary transmission takes place through various instruments such as credit, deposits, exchange rate and effects. In the current rate cutting cycle, the transfer via credit and deposits was strong, which improves and accelerates the impact of monetary policy. Since February 2025, RBI has lowered policy figures by 100 GDPs and, more importantly, applied substantial and durable liquidity. The effect of this is clear in reducing the cost of bank credit and deposits. Fresh loan figures are lower with 71 bps, and fresh deposits with 87 bps. The bond market is the other key instrument for transferring monetary policy, and this is where the impact was unexpected. After the June policy, where RBI pre-loaded policy action with a cut of 50 bps, G-SEC yields rose only, both short and long lasting. This effectively reduced the transfer of the speed reduction, especially to the long end. That said, comparing the transmission via loan and deposit rates with the bond market can be unfair. Former markets also reflect the expectations of policy changes in the market. The prolonged returns reflect the expectations of rate changes, while the short-term returns reflect the actual rate changes. The expectation channel of the bond market is an additional tool for monetary policy to influence financial conditions by indicating a possible change in policy. This enables faster transfer of monetary policy, as bond markets reflect policy changes before the actual change. Indeed, 10-year G-SEC yields began to reduce from October 2024 when RBI changed the attitude of the withdrawal from accommodation to neutral. The actual rate reduction cycle began from February 2025. In the same vein, the increase in prolonged returns after the June policy was due to a change in expectations, with the position of the policy of accommodating to neutral. The RBI’s change was made to indicate that the bar for further speed cuts was much higher. The rise in the prolonged returns thus reflects that the market is priceing in a long -lasting break. In the August policy, the RBI remained at break and uphill guidance upheld for limited space for further relief. This was shown by the RBI’s mention that the space provided by a benign inflation outlook is appropriately used to support growth. This further cemented the market view of a long -term break, which is reflected in an increase in prolonged returns. The returns in the short end reflect the actual policy action; However, they also rose after the 50 bps cut in June. They responded to the change in liquidity management by the RBI. The call rate, which is the overnight rate at which banks borrow money and borrow money, was before the June policy under the Repo rate. It effectively deepened the tempo cut cycle. The fall in overnight figures was due to the liquidity of the system that became positive due to RBI Serkidity infusion and the lack of reverse repo auctions (VRRRs). The latter temporarily absorbs the excess liquidity at a rate between the SDF and the Repo rate. However, after the June policy, RBI re -started, which led to the weighted average call rate rising closer to Repo. In July, the weighted average call rate was on average 5.40%, slightly below the 5.50% recovery rate. The cutting of 50 BPS of June was therefore effectively reduced to 25 bps with an increase in overnight. The returns at the short end reflect this. In the first place of the rate cut and the outlook on the yield, we see limited support for prolonged returns with the speed reduction cycle almost over. We see room for one more cut of 25 BPS in October, but the markets will only price it closer to the policy, once it becomes clear that inflation is likely to remain below 4%. Currently, RBI expects inflation to rise to more than 4% by the end of the year, an average of 4.7% in Q4FY26 and Q1FY27. This limits the space to further facilitate the rates. Given the positive monsoon performance and subdued food price trends, we see that inflation in Q4FY26 and Q1FY27 remains at 3.8%. The short-term returns not only get support from another rate reduction, but also a significant build-up of the liquidity of the banking system as soon as the CRR cut comes into effect. The CRR is cut by 1% from September to November, resulting in a £ 2.5 lakh crore infusion of durable liquidity. The G-SEC yield curve is likely to remain steep, which reflects that the speed reduction cycle is almost over, but the support of liquidity infusion will remain. (Gaura Sengupta is chief economist at the IDFC First Bank.) Disclaimer: This story is for educational purposes only. The views and recommendations expressed are those of individual analysts or brokerage firms, not coin. We advise investors to consult with certified experts before making investment decisions, as market conditions can change quickly and conditions can vary.