Nomura pushes back RBI rate cut call by 4 months, hikes FY24 inflation forecast by 50 bps

Nomura expects the RBI to raise its inflation forecast for 2023-24 in August wile announcing a “hawkish hold” in terms of interest rates.

Nomura has pushed back its repo rate cut call by four months to early 2024, saying the surge in food prices in recent weeks have "materially changed India's inflation outlook".

"The changing inflation dynamics mean that the RBI (Reserve Bank of India) will likely raise its 2023-24 inflation forecast at the August 10 policy meeting, where we expect a hawkish hold," Nomura economists Sonal Varma and Aurodeep Nandi said in a note on July 27.

"We are also pushing out our forecast timing of the RBI's first cut to February 2024 due to the rise in headline inflation, domestic demand holding up better than we had expected, and our house view of a delayed US recession," they added.

Nomura had previously expected the RBI's Monetary Policy Committee (MPC) to start cutting the repo rate in October after the rate-setting panel stayed pat in April and June, having raised interest rates by 250 basis points in 2022-23 to 6.5 percent.

One basis point is one-hundredth of a percentage point.

Consumer Price Index (CPI) inflation had eased to a 25-month low of 4.31 percent in May before it rose to a more-than-expected 4.81 percent in June. In July, data for which will be released on August 14, economists see inflation crossing the upper bound of the RBI's 2-6 percent tolerance range for the first time in five months.

The sharp rise in inflation in June was driven by the fading away of a favourable base effect as well as rising food prices. However, the latter force is now seen becoming stronger, with Nomura predicting CPI inflation will shoot up to 6-6.5 percent in July and August on the back of a huge jump in tomato prices in particular. While this price spike is seen as a transient, the rise in prices of other food items such as cereals, especially rice, pulses, and spices "could prove much stickier".

As such, Varma and Nandi have raised their inflation forecast for 2023-24 by 50 basis points to 5.3 percent. The RBI, meanwhile, sees inflation averaging 5.1 percent in the current financial year.

Easing core inflation

While the outlook for headline retail inflation has seemingly darkened, policymakers could find some solace in easing core inflation.

According to Nomura, the momentum in core inflation – inflation excluding food and fuel items – has fallen sharply. Moneycontrol calculations show core CPI inflation fell to 5.1 percent in June from as high as 6.1 percent in February thanks to declining input costs and subdued services inflation.

"We expect continued core disinflation due to lower manufacturing costs and softer consumer demand. On our forecasts, core inflation is likely to drop below 5 percent in July and then trend towards 4.5 percent by March 2024, despite the rise in food prices," Nomura's economists said.

On the whole, Nomura expects the RBI to raise its inflation forecast for 2023-24 by 20 basis points to around 5.3 percent next month, but look through the ongoing inflation spike given its likely temporary nature.

"While inflation breaching 6 percent in July would be optically bad, the jump would be almost entirely due to vegetables, while underlying inflation is stable or moderating. However, we expect a hawkish hold at this meeting, as the MPC needs to guard against potential second-round effects," Varma and Nandi said.