View| Will inflation shocker push MPC for a rate hike in October?

The next MPC meeting is scheduled on October 4-6

Everyone expected a jump in the consumer price index (CPI) inflation number for the month of July due to the higher vegetable prices. Yet, the July inflation number at 7.44 percent came much higher than all expectations. It did surprise most economists. What does this mean for the monetary policy?

To meet the average 6.2 percent RBI target for the second quarter, inflation will have to average below 6 percent in August and September. This looks tough as high food prices are a big concern at this point. Will this force RBI to bite the bullet?

As Moneycontrol reported on August 14, some economists indeed expect the RBI to hike rates by a quarter basis points in view of the higher inflation number. But, there are others who don’t subscribe to this argument. A quick analysis of some key points would give us reasons to think that the RBI may continue to hold rates and not immediately switch to a rate hike.

One, the spike in vegetable prices is typically short-lived; these price levels typically don't sustain. A period of high food prices typically follows a decline in a few months' time due to supply-side measures in most cases and seasonal factors. In the current phase, there have been some measures taken by the Government already to control sharp spikes in the prices of items such as tomatoes which had shot up 200 to 300 percent in recent months. Theoretically, the RBI has no control over the supply-driven price spike. It can only control demand by making money costlier to borrow. At this point, the central bank may rather wait to see how the vegetable prices are likely to behave in the approaching months and how the earlier price actions are playing out.

Two, One key metric the RBI keeps a close watch on is core inflation, which is the non-volatile part of retail inflation. The core inflation has remained largely under control. On a year-on-year-basis, the core inflation actually fell to five percent partly aided by the base effect. This is the fifth month in a row that the core inflation logging below six percent. Further expected fall in core inflation could offer more comfort to the rate-setting panel.

Three, The RBI will also be watchful about the pace of growth recovery. Not all is well on the growth-front. India's industrial output grew by 3.7 percent in June. At 3.7 percent, the latest industrial growth figure as per the Index of Industrial Production (IIP) is at a three-month low. It is also below the consensus estimate of 5 percent. A rate hike at this stage could upset the early recovery momentum in the economy, which the Government will not want to happen.

Against this backdrop, the most likely scenario will be a continuation of the rate status quo in the next policy review. Inflation print for August, September and October will be key to watch.