Inflation expected to cool down but economists expect another rate hike after January shocker

• Economists expect inflation to cool down and drop to 5% by April this year, comfortably below the upper tolerance limit of 6% set by the Reserve Bank of India.
• However, the January inflation print shocker has led to economists revisiting their expectations of a pause in rate hikes, with consensus building up for a 25 basis point hike in April.
• Scratching the surface of inflation data, though, economists point at data anomalies and some are waiting to see if a revision in January inflation print takes place.
• RBI governor Shaktikanta Das will also have to tame the unpredictable food inflation before he can declare victory.

Economists expect inflation to cool down and drop to 5% by April this year, comfortably below the upper tolerance limit of 6% set by the Reserve Bank of India. However, in an about turn of sorts, economists now expect another 25 basis point rate hike in April when the central bank’s next monetary policy meet is scheduled.

Inflation print for January 2023 sprung a surprise, with the consumer price index (CPI) rising to 6.52% while economists expected it to be between 6% to 6.2%. Core inflation edged up to 6.22% in January, from 6.1% in December.

This has pushed back the estimates of the economists at SBI Research, who now believe inflation will cool down to 5% by April this year, as against the previous estimate of March.

“Inflation will decline materially and come down to 5% by April 2023. For Q1 FY24, we expect an average CPI of 5.1%,” said a report by SBI Research.

RBI has hiked repo rates six times since May 2022 so far, taking the quantum of hikes to 250 basis points and the repo rate from 4% to 6.5%.

Another rate hike on the cards

The inflation shocker in January has resulted in economists revisiting their previous expectations of a pause in rate hikes – they now expect the RBI to deliver one more 25 basis point rate hike in April.

“With the inflation sticker shock in January, we now expect the RBI to hike rates at least one more time by 25bps in April, taking the repo rate to 6.75%,” Kaushik Das, chief economist, India & South Asia, Deutsche Bank.

To be sure, RBI governor Shaktikanta Das underlined quite clearly that the battle against inflation is not over yet. Das had said that the central bank has ‘Arjuna’s eye’ on inflation during the December announcement, and the said eye was still firmly on inflation during the February announcement as well.

Das said that the overall monetary conditions are still accommodative. Coupled with sticky core inflation, it makes a case for further monetary policy action, he noted.

“Adjusted for inflation, the policy rate still trails its pre-pandemic levels,” Das said, adding that we need an unwavering commitment to bring down inflation. “The 25 basis point rate hike is seen as appropriate. Reduction in the size of rate hike lets us evaluate the effect of rate hikes taken so far,” he said.

Post the inflation surprise, economists are now coming around to the possibility of another hike come April.

“In the absence of any data revisions, the overall inflation trajectory looks heavily skewed to the upside, warranting further rate hikes,” said Kotak Securities.

The brokerage said that it will wait to see if the data anomalies observed in the inflation numbers lead to a revision of the inflation print, before revisiting its view on a pause in rate hikes.

On the other hand, analysts at Bank of Baroda remain firm in their view that RBI will pause rate hikes for now.

“This month and print of the current quarter hold relevance since the RBI would be watchful of the persistence in core and volatility in food inflation to take a call on rates. For now, we remain with our earlier forecast of a pause in the near to medium term,” said Dipanwita Mazumdar, economist, Bank of Baroda.

Inflation shocker partly due to data anomalies, say economists

While the high inflation print has come as a shocker, especially when it is usually expected to come in lower in the month of January, economists suggest data anomalies could be partly to blame for it.

Economists at SBI Research noted that they are “perplexed” that there is no linkage between the vegetable prices tracked by the Ministry of Consumer Affairs, and the CPI data. This, they said, has resulted in an anomaly in the inflation print by at least 26 basis points.

The research firm gave an example of the difference in vegetable prices being tracked by the ministry as opposed to what is reflected in CPI data. According to the ministry, vegetable prices fell 10% in January, but CPI data shows a decline of 4% only.

“This anomaly is making it a nightmare to predict vegetable prices data,” the research firm noted.

Nomura also said in a note that it has noticed a divergence in the headline cereal inflation, and the sum of its components.

Sticky core inflation is sticky

Das has been reiterating his concerns about stickiness in core inflation, but the economists at SBI Research maintain that core inflation has always been sticky.

“Core CPI data since June 2014 indicates that stickiness is the normal property of core inflation,” the research firm said, noting that the average core inflation since June 2012 is 5.8%, as compared to the existing core inflation of 6.22%.

It added that this was due to a shift in consumer expenditure patterns towards health and education, and gold purchases.

While Das wants a meaningful reduction in inflation, economists at SBI Research say that this will have to be achieved only through a reduction in food inflation. However, its unpredictable nature, as observed in the January inflation print, means that RBI’s task is cut out and Das has an unenviable job at hand.

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