March inflation shocker: Street sees early and more rate hikes

The Consumer Price Index (CPI) for March rose to 6.95 percent because of mostly sharp price increases in a wide range of goods and services – edible oils (expected after the Russia-Ukraine war), meat, eggs, fish, vegetables, pulses, clothing, footwear, household goods and services, transportation, health goods and services.

Also Read | Inflation spike drives 10-year bond yields to fresh 3-year peak at 7.2%

Food inflation was up 7.68 percent from a year ago, while core inflation (excluding food and fuel) jumped to 6.4 percent from 6.1 percent a month ago.

The almost 1 percent month-on-month jump in March inflation has pushed up the CPI index number so much that inflation readings will have to be revised higher for several succeeding months. Economists now expect CPI readings of over 6 percent all the way till September. Readings in January, February and March are already above 6 percent.

POLICY IMPACT

CPI of 6 percent-plus for three consecutive quarters will bring the inflation-targeting monetary policy framework into play. This framework mandates the MPC to keep inflation at 4 percent, plus or minus 2 percent, or between 2 percent and 6 percent.

Also Read | New lessons in managing inflation in the West: KV Kamath

If CPI remains above 6 percent for three quarters in a row, the RBI must write to Parliament explaining why it failed in its mandate and also take steps to bring CPI back under 6 percent.

The only instrument the MPC and the RBI have to drag down inflation is hiking the repo rate. Hence the widespread expectation that India’s rate-hiking cycle will start in June.

MARKET IMPACT

Bond market yields have been surging since the Russia-Ukraine war and more sharply since the April 8 policy, when the RBI changed its stance to “withdrawal of accommodation.”

With the massive government borrowing programme also kicking in this week, 10-year government bond yields may remain above 7.25 percent, which will in turn pull up the cost of borrowing for companies.

Equities may take the expected rate hikes in their stride, as is being witnessed in the US. In the early stages of an inflation and interest rate hiking cycle, equities normally do well as firms that have pricing power are able to pass on raw material inflation to consumers via higher product prices. Such companies see their revenue and earnings rise in nominal terms.

It’s only in the latter part of the rate-hike cycle, probably after a dozen or more hikes, that the economy slows down and lower demand hurts earnings per share.