Inflation expectations spoil case for rate hike pause

Inflation expectations spoil case for rate hike pause

The recent slide in global commodity prices after the world economy was hit by fresh tremors this month has led to demands for the Reserve Bank of India (RBI) to pause in its long battle against inflation, which has been close to double-digit levels for 18 months. The Indian central bank had surprised the markets in July, when it increased its key short-term lending rate by a stiff 50 basis points in order to send out a signal about the growing scale of the inflation problem.

A lot has changed since that policy move, especially new global shocks. It is quite likely that domestic price pressures will reduce in the coming quarters if the US, China and Europe slow down. Indian inflation does tend to move in sync with global commodity prices.

However, inflation expectations of households continue to climb. The latest household survey conducted by the central bank for the April-June quarter shows that inflation expectations a year ahead continue to rise -- from 12.7% to 12.9%. The results were made public on Thursday.

When citizens expect inflation to continue climbing, they usually demand higher wages, pushing up costs for employers. Inflation expectations have been far higher than the actual rate of increase in the consumer price index, a sign that policy makers are losing the delicate battle to anchor such expectations. “Unlike in last round of the Survey, the percentage of respondents expecting price rise has gone up for all product groups (viz., food, non food, households durables, housing and services)," the central bank stated on its website.

A rerun of the chaos that the world saw in the aftermath of the collapse of Wall Street investment bank Lehman Brothers in September 2008 seems unlikely. The RBI had to quickly reverse course and cut interest rates in response to the severe tightness in the domestic financial markets and the slide in the rupee as money fled India. The current crisis may not be like the Lehman earthquake, in which case the Indian central bank may continue with its vigil against inflation for quite some more time.