Governor Mark Carney and the other eight members of the bank's rate setting Monetary Policy Committee have been signalling that a hike is likely to come at some point in 2018 since their last hike in November past year, and Thursday looks like the day it will happen.
The six-member Monetary Policy Committee headed by RBI Governor Urjit Patel kept its stance at neutral.
Simultaneously, it raised average inflation projection for 2018 second half from 4.7% in June to 4.8%.
Minutes from the MPC meeting noted: "Taking these influences together, and conditioned on the gently rising path of Bank Rate implied by current market yields, CPI inflation remains slightly above 2% through most of the forecast period, reaching the target in the third year".
The central bank said that GDP growth rate for the April-June quarter is seen at 7.5-7.6 per cent while maintaining the FY19 growth rate at 7.4 per cent.
"Longer term fixed rates are likely to be more popular now among borrowers as they try to protect themselves from future base rate rises".
The RBI's rate move is the second in eight weeks and follows emerging-market counterparts in Indonesia, the Philippines and elsewhere who are trying to counter currency routs and inflation risks triggered by higher U.S. rates and a stronger dollar.
Mumbai: With the Reserve Bank of India (RBI) raising the repo rate by a quarter percentage point to 6.5%, the second such hike in two months, money will become more expensive in the world's fastest growing major economy.More news: Foreign Influence Investigations Spanning U.S. to Confront Election Threat
Nevertheless, investors have put nearly a 90 percent chance on a hike in Bank Rate to 0.75 percent from 0.50 percent on Thursday, according to market prices. RBI had to choose the timing of rate hike between now and later in the October 2018 policy.
Today's hike in interest rates will make loans more costlier in the coming days.
Economists have challenged the need for a rate hike now, given the Brexit risks and the potential for an escalating tariff conflict between Washington and Beijing to hit the global economy.
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...
"May would be my guess for the next hike", said Kallum Pickering, a United Kingdom economist at Berenberg.
"Limited, because we think the structural factors that have pushed down the trend equilibrium real rate are likely to persist".
RBI had increased rate by 25 bps in the previous policy review after four-and-a-half years. Higher government prices for some food crops also poses upside risk to inflation.
"Subsiding consumer and business confidence, especially in forward looking gauges, together with the responses to the Ipsos Mori opinion poll, suggest strongly in our view that private sector economic agents are increasingly and demonstrably not behaving in this way", Wraith concluded.