The chart from IndusInd Bank chief economist Gaurav Kapur shows that core inflation (non-food, non-fuel inflation) quickened sharply in January, in spite of the headline CPI (Consumer Price Index-based inflation) coming in at a very low 3.17%, the lowest in the new series. “The high core inflation vindicates the Reserve Bank of India’s decision not to lower its policy rate at its last meeting,” said Kapur. Most of the fall in inflation has come on account of tumbling food prices, aided and abetted by distress selling due to demonetisation. Food inflation was a mere 0.53% last month, pulled down by vegetable prices, which were lower by 15.6% than a year ago.
The central bank is wary of reducing interest rates at a time when core inflation continues to be sticky, as any shock through either higher commodity prices or a poor monsoon could feed into higher headline inflation. This is particularly true as the Reserve Bank of India (RBI) is aiming at a 4% medium-term inflation target. That said, much of the rise in inflation seen in the “Miscellaneous” services category was on account of “transport and communication”, due to higher fuel prices.
Bond yields have moved up sharply after RBI unnerved the markets with a shift to a “neutral” stance in monetary policy, from its earlier accommodative one. The rise in core inflation is likely to reinforce the negative sentiment in the bond market, especially as RBI has of late been harping on core inflation being sticky.