Subdued core inflation, an indicator of weakness in the economy, may offer the central bank some comfort. (Bloomberg)
Subdued core inflation, an indicator of weakness in the economy, may offer the central bank some comfort. (Bloomberg)

A tale of two contradicting inflations: Brace for one last interest rate cut before a pause

  • Subdued core inflation, an indicator of weakness in the economy, may offer RBI some comfort
  • Expectations of a rate cut on 5 December are largely intact. Many economists are working with a 25 basis points (bps) interest rate cut

Food supply shortages due to seasonality pushed India's headline retail inflation in October beyond the central bank's crucial 4% mark. Inflation measured by the consumer price index (CPI) touched 4.62%. Recent surge in vegetable prices, especially those of onions and tomatoes weighed on overall food inflation. While headline inflation is highest since June 2018, core inflation has slipped to lowest level in the new series. Core inflation (headline inflation excluding food and fuel) slipped to 3.5% in October.

Subdued core inflation, an indicator of weakness in the economy, may offer the central bank some comfort. However, economists expect headline inflation to remain high for the rest of this financial year. These contradicting signals come at a time when India’s economic growth continues to falter confirmed by disappointing September industrial output data. So, taking a call on future interest rate decisions would be tricky for the Reserve Bank of India (RBI).

But for now, the central bank may chose to focus on reviving growth than worrying about inflation. Given the poor transmission of earlier rate cuts on bank lending rates, RBI is expected to fix the widening output gap. "The first above-target inflation reading since July last year should not push the Reserve Bank of India off its rate-cutting course. While the headline figure is being driven by a spike in food prices that should prove temporary, core inflation has fallen to a historic low," economists at independent research house Capital Economics said.

So, expectations of a rate cut on 5 December are largely intact. Many economists are working with a 25 basis points (bps) interest rate cut. One basis point is one hundredth of a percentage point. However, after that the central bank's interest rate decision is likely to be data-driven.

“While the December rate action would mostly likely entail a cut of 15-25 bps in the repo rate, the MPC would also signal a pause going forward. While maintaining an accommodative stance, any further rate easing would become data dependent, with higher weight on incoming data and assessment on growth, while maintaining a cautious approach on inflation and upside inflationary pressures," Gaurav Kapur, senior vice president and chief economist at IndusInd Bank said.

Meanwhile, fears of inflationary pressures making a comeback are catching-up globally. Bank of America Merrill Lynch’s latest global fund manager survey pointed to rising expectations of elevated inflation. Inflation expectations surged in November with 31% of those surveyed expecting higher global CPI in the next 12 months, but still well below cycle highs, said the report.


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