Mumbai: The Reserve Bank is likely tighten monetary policy further on 29 July to limit rising inflation expectations. Poor rainfall, higher steel prices and uncertain oil prices pose upside risk to inflation, while the shift in government’s policy preference and upcoming elections provide political support for more tightening.
The headline WPI inflation has surged to a thirteen-year high of 11.89% – up by more than 365bp over the past eight weeks.
Although the WPI inflation was already widely expected to stay in double-digits until end-2008, the momentum in prices continues to nudge inflation expectations higher.
We project inflation will scale up steadily to a peak of 13.5-14% in the October-December 2008 quarter, even without additional fuel price hikes. Further, inflation is likely to shrink back to single-digits only in the first quarter of 2009.
While the real sector data so far exhibits mixed signals, indications from the finance ministry suggest that taming inflation is the key priority.
The political sensitivity to high inflation thus provides the RBI with the leeway further tighten monetary conditions.
We expect the RBI will hike the repo rate by 50bps at its quarterly policy review tomorrow. We also expect a 25bp CRR hike, although recent tight money market conditions reduce the probability of a CRR hike.