RBI increases key rate to 6.5% on inflation worries

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The rate action was in line with a Reuters poll last week, which showed 37 of 63 economists expecting a rate increase.

It's because banks use the figure as a reference for the amount they either pay or charge.

However, if companies pass on the recent GST rate cuts, some of the impact of inflation will get moderated.

Interest rates were cut to 0.5% in March 2009 when the markets were in the grip of the banking crisis and remained at that level until August 2016 when they were cut to 0.25% in the aftermath of the European Union referendum.

Where will rates go from here?

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Policymakers at the Bank said that momentum in the economy had recovered after an initial dip in the first three months of the year, which was believed to be caused by... "For example, the average five-year fixed rate has increased by just 0.05% since November 2017 stand at 2.93% today". It had looked set to move in May before Carney stepped in to steer markets towards no change in policy.

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"The main argument for raising rates now is that it gives the Bank more room for manoeuvre when the next downturn hits".

What does the interest rate rise mean for me?

In reality, however, it's not so simple.

Mark Carney's press conference will also be of interest, particularly if the governor provides an update on the equilibrium rate of United Kingdom interest rates. However, HSBC confirmed it will apply higher rates from tomorrow.

Fixed-rate mortgages started to rise after November's increase.

It's hard to tell how much of an impact the latest rise will have. That figure is now 90% for new mortgages, and two-thirds of all home loans.

Image copyright Getty Images Luis asks: What is the reason for increasing interest rates when the economy has a slowdown?

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The central bank also said indicators suggested that economic activity continued to be strong.

However, lower-than-expected inflation figures - unchanged at 2.4% in June - and weak wage growth had placed a question mark over the increase for some. This is slightly lower than the 2.5% rate expected by the Bank in its forecast three months ago.

Killol Pandya, Head, Fixed Income, Essel Mutual Fund, said, while market is discounting a rate hike, he believes it is a touch-and-go matter with nearly even probability of rate action. Now is a good time to consider switching your banking products, as banks will be reviewing their rates. "The RBI may continue to focus on inflation, fiscal deficit and global geopolitical uncertainties".

Of course, these are not normal times.

Policy stance would remain "neutral".

The decision to raise rates would come as a blow to some borrowers on variable rate mortgages, but would offer relief to savers who have seen paltry returns on deposits since rates have languished at 0.5% or below since 2009.

A Bank rate rise does not guarantee the equivalent increase in interest paid to savers.

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