CPI Inflation at 15-month peak pushes rate cut target to FY25; RBI likely to be on wait & watch mode

While the Indian markets were already suffering from weak global cues, a shock came from the domestic side when the headline inflation in the economy surged to a 15-month peak.

India's consumer price index (CPI) inflation print in July came in at 7.44%, much above the Reserve Bank of India's (RBI) upper tolerance limit of 6%, driven by high food and vegetable prices. The retail inflation in June was 4.81%.

However, core inflation data was seen as a relief. The core inflation, which excludes food & beverages and fuel & light, fell to 4.9% from 5.1% in June, the lowest in almost three years.

Read here: India's retail inflation surges to 7.4% in July on high vegetable prices; food CPI highest since October 2020

Analysts believe this reinforces that the current surge in inflation is transitory and will correct in 2-3 months.

Amid a wide perception that the high inflation would not last long and is just transitory, economists and analysts believe the RBI’s Monetary Policy Committee (MPC) will not hike interest rates in its next meeting, but the hopes of a rate cut has further pushed to early FY25.

Prasenjit Basu, Chief Economist, ICICI Securities thinks the MPC will be reassured by the moderation in core inflation, and thus will see no further need for monetary tightening to deal with this unexpectedly-large spurt in headline inflation. 

The financial market saw a knee-jerk reaction to the higher than expected inflation data as investors will now look ahead to the RBI’s September policy.

On August 10, the RBI delivered a ‘hawkish pause’ as the MPC remained cautious on inflation. The central bank kept the repo rate unchanged, but raised CPI inflation forecast for FY24 to 5.4% from 5.1% earlier. The inflation forecast for Q2FY24 was raised to 6.2% from 5.2%.

Read here: RBI Policy Meeting Highlights: RBI Governor Shaktikanta Das delivers ‘hawkish pause’; remains cautious on inflation

RBI Governor Shaktikanta Das maintained his hawkish tone by indicating that the MPC was ready to act if the inflationary pressures broaden. He emphasized that the MPC targets to align inflation to the 4% mark. 

“We expect an upward revision in RBI’s 6.2% inflation expectation in Q2FY24 after the hotter than expected CPI print in July. We believe that the RBI’s policy decision last week had factored-in current Inflation print, moreover comfortable core inflation in July would act as a buffer for RBI to not tinker with the policy rates. Hence we continue to expect an extended pause unless inflationary pressures broaden across categories till MPCs next meet in Sep’23,” said Hitesh Suvarna of JM Financial.

He continues to believe that the policy rates have peaked and does not expect rate cuts in CY23. 

By maintaining inflation projection above 5% in Q1FY25, RBI further pushed rate cut expectations, he added.

Also Read: Cooling core inflation fails to cheer amid supply flux

Pankaj Chhaochharia of Antique Stock Broking believes that we are at the end of the rate hike cycle as the current real policy rate is at a restrictive level of 1.3% as against a neutral rate of 0.8%-1.0%. 

“We expect that the rate cut cycle may resume from 1QFY25 (as against earlier expectation of 4QFY24) given the delayed consensus expectation of a rate cut cycle in the US,” he said.

On the domestic equity market front, V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services believes there are strong headwinds, both globally and domestically, that can impact the market in the near-term. 

Global headwinds are from the rising dollar index and spiking US bond yields. Consequently FIIs are selling, taking their cash market sell figure in August, till 15th, to ₹9,867 crore.

Also Read: RBI's inflation targeting: Challenges ahead

“Domestically, the major headwind is rising inflation. July CPI inflation has come at 7.44%, which is 1% above consensus estimates. The CPI inflation for FY 24 will have to be revised upwards to 5.6%. The takeaway from this is that a rate cut can be expected only in H2 of CY24,” said Vijayakumar.

He believes this is negative for rate sensitives. So, the banking sector, which has been a pressure point for the Nifty, is likely to experience more near-term pain, he added. 

“But for long-term investors, the correction can be an opportunity since the sector is doing well and valuations are fair.  Defensives like pharmaceuticals and IT will be relatively safe in the near-term. Rupee will weaken,” said Vijayakumar.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.