India's central bank raised its benchmark interest rate more than forecast to quell the fastest inflation among major economies, spurring a slide in stocks and gain in the rupee.

The Reserve Bank of India increased the repurchase rate to 8 percent from 7.5 percent, it said in a statement in Mumbai today. None of the 22 economists surveyed by Bloomberg News predicted today's decision. Twenty estimated a quarter-point rise, while the remainder expected no change.

Governor Duvvuri Subbarao acted as the central bank elevated its inflation forecast for the year through March by 1 percentage point, to 7 percent. With rising rural wages and a lack of corporate investment growth straining capacity, India's price pressures mean it lacks the leeway in setting monetary policy afforded to counterparts in South Korea, Malaysia and Indonesia, which kept borrowing costs unchanged this month.

"Today's policy action will reinforce the point that in the absence of complementary policy responses on both demand and supply sides, stronger monetary policy actions are required," Subbarao said at a press conference in Mumbai today. "A change in stance will be motivated by signs of a sustainable downturn in inflation."

India's benchmark wholesale-price inflation, which quickened to 9.44 percent in June, may remain near 10 percent until November, according to HSBC Holdings Plc and Yes Bank Ltd. By comparison, consumer prices rose 6.7 percent in Brazil, 9.4 percent in Russia, 6.4 percent in China and 5 percent in South Africa.

David Fuller's view Markets do not like unpleasant surprises and a larger than expected interest rate hike certainly qualifies. However, larger rate hikes almost invariably occur in the latter stages of a monetary tightening cycle.

We last saw this between June and August 2008, when the Reserve Bank of India raised its REPO rate (Bloomberg has yet to update this chart but the rate is now 8%) in two 50 basis points hikes taking it from 8% to 9%, where they stayed until the first in a series of sharp cuts commenced in October.

RBI governor Duvvuri Subbarao is unlikely to know where he will halt rate hikes, since this depends mainly on India's inflation, but he is likely to do what he considers necessary. This poses a near-term risk for India's stock market (weekly & daily). Foreign investors have been buying in recent months and would have been aware of upward pressure on rates. We may be about to find out if their nerve holds.

Personally, I am in for the long term and remain a likely buyer on weakness.