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Thursday, January 15, 2015

Did the stock market over-react to the 25 bps interest rate cut by RBI?

The short answer to the question is: Yes. Why?

Low inflation during the past few months had increased the likelihood of an interest rate cut sooner than later. It was widely expected that RBI will start slashing interest rates from Feb ‘15 onwards.

While some experts were touting a 50 bps (i.e. 0.5%) cut, the consensus estimate was a 25 bps (i.e. 0.25%) cut in the repo and reverse repo rates to start with, followed by two or three more cuts - totalling 1% for the calendar year 2015.

In other words, a 25 bps rate cut in Feb ‘15 was already ‘discounted’ in the stock indices. But the surprise announcement by RBI of a rate cut before the stock market opened for trading today was a positive trigger for the market to get out of its consolidation mode.

It was definitely good news. But was it great news? I don’t think so. A 25 bps cut in the repo rate means that the rate will drop to 7.75% from 8%. That means the corresponding lending rate to companies by banks will drop from say 12.5% to 12.25%, and home loan rates may go down from 10.75% to 10.5%.

Will that cause a stampede towards banks by companies, or towards housing finance companies by home buyers, from tomorrow? Highly unlikely. Companies or home buyers don’t take decisions about large investments merely because interest rates go up or down by 0.25%.

Why then did Sensex gain more than 700 points, and Nifty move up by 200 points? Those holding shorts had to rush to cover. That gave the initial impetus to the market. Technically also, Sensex and Nifty were poised to break out from consolidations within ‘symmetrical triangle’ patterns. The surprising rate cut news provided a positive trigger to bulls.

So, did you miss buying today? Not to worry. Many others did too. And remember that one day doesn’t make or break your ability to make money.

When realisation dawns on market players that today’s buying was a bit overdone, profit taking will emerge. The likely dip can provide an entry point.

Things are getting in place for stronger economic growth. Today’s rate cut was a small step in the right direction. This bull market will be ascending new heights again.

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