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Inflation may cool off in next 2 quarters, another 50 bps RBI repo rate hike likely in September

Retail inflation is likely to ease going forward, with an improved supply side situation and global economic weakening leading to falling energy prices

Inflation may cool off in next 2 quarters, another 50 bps RBI repo rate hike likely in September
India's CPI inflation reversed a three-month downtrend, soaring to 7% again in August, due to rise in food price (Picture Bloomberg)

India’s CPI inflation reversed a three-month downtrend, soaring to 7% again in August, due to rise in food prices. Higher prices for items such as wheat, rice and pulses offset easing edible oil prices, leading to a rise in food prices in August. Inflation has now remained above the Reserve Bank of India’s (RBI) medium-term target of 4% for 35 consecutive months, and above the central bank’s 2-6% tolerance range for eight straight months. According to economists, retail inflation is likely to ease going forward, with an improved supply side situation and global economic weakening leading to falling energy prices.

Inflation to ease in 2023 with improved supply, falling energy prices

“Inflation numbers dashed hopes that price levels are going to level off. While food inflation was the primary reason owing to erratic monsoon impacting production, the core CPI data, which is less volatile and also reinforces the expectation of inflation, inched up. This shows just how much work the RBI has to do. The challenge is that the RBI is faced with a difficult balancing act, needing to raise interest rates aggressively to control inflation without impacting the recovery,” said Rumki Majumdar, Economist, Deloitte India. Majumdar expects inflation to ease in 2023, with an improved supply side situation and global economic weakening leading to falling energy prices.

Also Read: Inflation rises to 7 per cent in August; RBI may hike interest rate again later this month

Combination of slightly higher inflation, marginally slower growth unlikely a big concern for policymakers at this stage

“August headline inflation came in at 7% in August, in line with Motilal Oswal Financial Services’ expectations, but higher than the market consensus of 6.9%. Food inflation surged to 7.6%, led by 103-month high inflation in cereals. Core inflation, thus, surged slightly to 6.1% on -year in August, up from 6% in July. IIP, on the other hand, grew just 2.4% on-year in July, missing expectations,” Nikhil Gupta, Chief Economist, MOFSL group said. The combination of slightly higher inflation and marginally slower growth is not desired, he added. “However, it is unlikely to concern the policymakers and/or markets at this stage. We continue to believe another 50-60bps hike in CY22 (with 25-35bps hike in Sep’22), taking the repo rate to 6% by Dec’22.”.

Falling crude, commodity prices may offer a respite for CPI and IIP data going forward

“It’s a double whammy of sorts on the economic data. On a downward slide since April, the CPI rose in August to touch a 7% level. Primarily the rise is due to food, vegetable, and pulses that has led to a rise in CPI. Higher energy prices also pushed inflation higher. The industrial production data too had a negative reading. After double-digit growth in May and June, the July industrial output has dropped to 2.4% making it a 4-month low, said Nish Bhatt, Founder & CEO, Millwood Kane International.

Higher crude, LPG, and commodity prices dragged the industrial output. According to Bhatt, falling crude and commodity prices may offer a respite for the CPI as well as IIP data going forward. “This latest economic data will have a bearing on the MPC meeting later this month. Central banks across the globe are raising rates, and curtailing system liquidity to tame the rising inflation,” he added.

CPI inflation to be back within MPC’s target range (2-6%) by Oct-Dec quarter

Rahul Bajoria, MD & Chief India Economist, Barclays expects inflation to undershoot the central banks forecasts by 20bps, at around 6.9% in the next quarter. “Indeed, While the RBI kept its forecast for FY 22-23 average inflation at 6.7% last month, to us, the risks are still clearly biased towards inflation surprising the RBI’s forecasts to the downside, as global commodity prices decline, and the government’s counter cyclical steps to shore up food supply should work over a three- to six- month period”, he said adding that CPI inflation will be back within the MPC’s target range (2-6%) by October-December quarter.

Also Read: Food inflation rises to 7.6 per cent in August

RBI to hike rates by 50bps again in September

From a policy perspective, another month of above-target inflation clears the path for further monetary tightening at the next MPC meeting on 30 September, according to Bajoria. “While several supply issues appear in control, and inflation projections are biased lower, we still sense that the relatively resilient growth outlook, coupled with strong credit growth and sticky core inflation, will keep the RBI’s focus firmly on managing inflation,” he said. Analysts at Barclays now expect RBI to deliver another 50bp rate hike in September, taking the repo rate to 5.90%, which should also be the time when real rates reach levels desired by the MPC. “If inflation remains sticky, we believe the RBI can continue hiking in December, although we now expect no action in December, as things stand,” Bajoria added.

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