Inflation is falling but don't uncork the bubbly yet

While vegetable prices have come down, some food items such as cereals and pulses continue to face price pressure.

Will the easing of retail inflation in the month of August prompt a change in the rate stance within the monetary policy committee (MPC)?

Let's look at the numbers first. The primary reason for the fall in retail inflation to 6.83 percent from 7.44 percent in July is a fall in vegetable prices. But, for MPC, the even bigger good news is the easing of core inflation, which is the non-food, non-oil part of the retail inflation, which too fell to 4.9 percent.

Both these factors should give some positive comfort to the rate-setting panel; but not enough to instil confidence in the panel to change the rate course at the next meeting in October.

Let's understand why:

One, the MPC has very clearly stated in the previous policies that the main focus is now to bring down inflation to 4 percent. The retail inflation still stay well above the 6 percent upper band and MPC will wait for inflation to ease below 6 percent for a few months in a sustainable manner. That hasn’t happened so far.

Two, while the overall food inflation has eased, price pressure continues on certain items like cereals, pulses and milk. These segments may offer price shocks ahead in the backdrop of uneven rains and lower reservoir levels, per economists. Similarly, the upward pressure on global crude prices may pose another risk. These are problematic areas where caution is warranted.

Three, the MPC has learned bitter lessons from its failure to keep inflation within the target band last year. Three consecutive quarters of inflation breaching the upper band would make it mandatory for the central bank-led panel to acknowledge its failure in public. This time, the panel is even more cautious not to repeat the mistakes of the past.

Four, no one within the MPC wants to call an early victory over inflation. While inflation has shown signs of easing in recent months, the RBI itself expect further upward pressure going ahead. This is the reason the RBI revised its inflation target in the last policy for the current financial year to 5.4 percent from 5.1 percent. The RBI expects inflation in the second quarter of FY24 at 6.2 percent, third quarter at 5.7 percent and 5.2 percent in the fourth quarter.

Five, at the same time, what one could say with some degree of confidence is that a rate hike is ruled out at this stage. Easing inflation trend will give some confidence to the central bank on the inflation front to avoid pressing the panic button. The likely strategy is remaining on hold for the rest of the year till the time there is certainty of inflation inching closer to the 4 percent target.

The MPC is set to meet again in the first week of October to review the monetary policy. The comments of the members will offer more clues on the path ahead.