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Explainer| Will falling CPI inflation push the MPC for an early rate cut?

The CPI inflation has fallen within the central bank’s comfort zone in last the two months.

February 12, 2021 / 08:35 PM IST
Reserve Bank of India (RBI) Governor Shaktikanta Das

Reserve Bank of India (RBI) Governor Shaktikanta Das

The consumer price index (CPI)-based inflation, the key price indicator used by the monetary policy committee (MPC) for policy formulation, fell to a lower-than-expected 4.06 per cent in January compared with 4.59 per cent in December. The fall was largely on account of easing food prices. Let’s examine what the sharp fall in CPI inflation numbers mean for the monetary policy makers.

What is MPC’s inflation target range?

The MPC operates with a four per cent medium term inflation target within a band of two per cent on either side. Hence this is the second consecutive month the CPI inflation falls below the central bank’s comfort zone. In the last monetary policy review, on February 5, the MPC had kept the rates unchanged but remained on an accommodative stance.

CPI Inflation has remained above the six per cent band for eight consecutive months since April, 2020 before falling below six per cent in December.

Is a rate cut in the vicinity with the fall in January inflation print?


Not really. Most economists expect inflation to resume an uptrend in February and March with the base effect likely to fade going ahead.

Economists also point out that the sequential momentum in core inflation has risen. “Sequential momentum in core inflation has risen, following the highest ever WPI-Core momentum reading in December, rising mobility indicators and falling Covid cases,” said Sreejith Balasubramanian, Economist – Fund Management, IDFC AMC.

Core inflation, the non-food, non-fuel part of the inflation, remain high at 5.7 per cent.

“Going forward, the base effect which helped recent lower prints, will wane in February and March and the magnitude of disinflation in vegetables would also most likely ease, while the price movement in pulses and vegetable oils needs to be watched closely,” said Balasubramanian.

On February 5, the MPC kept the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 4.0 per cent. Consequently, the reverse repo rate under the LAF remains unchanged at 3.35 per cent and the marginal standing facility (MSF) rate and the Bank Rate at 4.25 per cent.

Since March 2020 (when the pandemic began), the MPC has cut the key lending rate, repo, by 115 basis points. Since February 2019, the rate cuts amount to 250 bps. One bps is one-hundredth of a percentage point.

CPI Inflation (PC-MoneyControl) CPI Inflation (PC-MoneyControl)


What is the MPC stance?

The MPC said it will continue with the accommodative stance as long as necessary – at least during the current financial year and into the next financial year – to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward.

Chances of a delayed growth recovery remains a worry for policymakers. Indian economy is likely to contract by 7.7 per cent in FY 21 hit by the pandemic.

But, despite the growth focus and inflation cooling off in two successive months, a rate cut is unlikely to happen soon as the inflation trend may surprise going ahead, economists said.

“With inflation expected to resume an uptrend in February-March 2021, we do not think that today's softer-than-anticipated print creates the room for an imminent rate cut,” said Aditi Nayar, Principal Economist, ICRA Ltd.

“Food prices have displayed a mixed trend so far in February 2021. The rise in onion prices, as well as higher crude oil prices and their transmission into retail fuel prices are areas of concern that need to be monitored,” Nayar said.

High inflation has been a persisting worry for the central bank. “The MPC notes that the sharp correction in food prices has improved the food price outlook, but some pressures persist, and core inflation remains elevated,” the RBI said in the monetary policy,” adding that it will closely watch the evolving policy outlook.

Most economists expect that the central bank may continue with the pause in policy rates for now along with the accommodative stance before shifting to a neutral stance later this year. It could tweak the rate stance depending upon the incoming inflation, growth data going ahead. For now, the wait and watch mode will continue.
Dinesh Unnikrishnan
first published: Feb 12, 2021 07:57 pm

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