A sharper-than-expected jump in Consumer Price Index (CPI) inflation of July could prompt the Reserve Bank of India (RBI) to increase interest rates sooner than expected, a section of economists told Moneycontrol on August 14.
However, some other economists said the central bank could continue with an extended pause and may watch inflation figures more closely.
India's headline retail inflation rate crashed past the upper bound of the Reserve Bank of India's (RBI) 2-6 percent tolerance range in July and shot up to a 15-month high of 7.44 percent, from 4.81 percent in June.
“Given this backdrop (Inflation numbers), another 25-basis point rate hike by the RBI is a distinct possibility,” said Sujan Hajra, Chief Economist & Executive Director, Anand Rathi Shares and Stock Brokers.
Further Hajra said a rate cut in the next 12 months appears extremely unlikely.
"The RBI will monitor not just the CPI number but also the factors that are driving it up. This also means that a rate hike cannot be ruled out for certain though the probability may be low," said Madan Sabnavis, Chief Economist at Bank of Baroda.
Last week, the central bank kept interest rates unchanged at 6.50 percent, consecutively three times in a row, after hiking 250 basis points (Bps) since May last year. One basis point is one hundredth of percentage point.
While leaving repo rate unchanged it made an upward revision in CPI inflation forecast by 30 bps for 2023-24
Why some economists saying pause?
The economists who expect rate pause said the central bank will closely monitor the evolving inflation situations and other global factors impacting inflation.
Gaura Sen Gupta, Economist, IDFC First Bank said the central bank is expected to look through the surge in inflation with headline expected to moderate to sub-6 percent in H2FY24.
Also read: July retail inflation at 15-month high of 7.44%
"Assuming food prices moderate in the coming months and core inflation stays well behaved, RBI is expected to remain on pause in FY24," Gupta added.
Similarly, Sakshi Gupta Economist HDFC Bank also said the RBI could continue on an extended pause but liquidity tightening could accelerate going forward.
Inflation numbers
The CPI inflation at 7.44 percent for July is 257 bps higher than the previous month's print and is the 46th month in a row that it has come in above the RBI's medium-term target of 4 percent.
The sharp rise in inflation was driven by higher prices for vegetables, with their index rising 38 percent month-on-month, resulting in a 6.7 percent sequential rise in Consumer Food Price Index and a 2.9 percent increase in the overall CPI.
The eye-watering CPI inflation figure for July is way above expectations, with economists having predicted prices likely rose by 6.6 percent.
Last week, the central bank in the monetary policy has made an upward revision to its inflation forecast for 2023-24, raising it by 30 basis points to 5.4 percent.
On this RBI Governor Shaktikanta Das said headline inflation projection for Q2 of 2023-24 has been revised up substantially, primarily due to the price shock from vegetables.
"Given the likely short-term nature of these shocks, monetary policy can look through high inflation prints caused by such shocks for some time.," Das added.
Also read: Rise in food inflation warrants guarded approach by govt, RBI: Finance Ministry
How bond market will react?
Money market experts expect that the yield on the 10-year benchmark 7.26 percent 2033 bond to rise by 4-5 bps on Thursday due to higher-than-expected CPI inflation figures.
“We need to wait and watch for Thursday, meanwhile in next 2 days what happens to US yields and crude shall also have some impact, by and large it’s likely to move up by 4-5 bps,” said Ajay Manglunia, Managing Director and head of the investment group at JM Financial.
Further, according to the Murthy Nagarajan, Head - Fixed income, Tata Mutual Fund the bond market will react to this adverse CPI number even though this rise in prices of vegetables is temporary.
On Monday, yield on the 10-year benchmark bond closed at 7.2034 percent, almost flat than its previous close at 7.2021 percent.
In the last few days, yield on the bond remained mostly range bound even after the central bank introduced incremental cash reserve ratio to temporarily remove excess surplus liquidity from the banking system.
Additionally, some dealers are also expecting the yield could touch 7.25 percent on Thursday. “Some dealers are expecting the yield could touch 7.25 percent on Thursday,” said Deepak Agrawal, CIO - Debt, Kotak Mutual Fund.
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