In an unfavourable turn of events, inflation measured by the Consumer Price Index (CPI) was at 3.65% year-on-year in August, up from 3.60% in July, and surpassing Mint's consensus estimate of 3.5%. Given the generous rainfall seen in August, expectations were that retail inflation would moderate as vegetable prices ease.
The unexpected uptick was largely driven by higher-than-expected food inflation, while core inflation remained benign.
“We believe that higher food price inflation is a statistical issue. Until July, food prices were higher. Now, although food prices are falling, it is not being reflected in the CPI data,” pointed out a Nomura Global Markets Research report dated 13 September.
The critical question now is how this affects the Reserve Bank of India's (RBI) anticipated timeline for interest rate cuts. The August CPI reading reduces the probability of an October rate cut to about 60%, down from 70% prior to the release, according to the Nomura report.
The RBI's next policy meeting, scheduled for 7-9 October, will take place after the September inflation figures are released. The weather department has forecast above-normal rainfall for September, and the development of La Niña conditions towards the month's end will be crucial for the monsoon's withdrawal. While headline CPI inflation remains below the RBI’s 4% target, news regarding food prices remains concerning.
“Daily retail prices indicate pick-up in food prices (on a month-on-month basis) in September. This is based on prices for the first two weeks,” said an IDFC First Bank report dated 12 September.
While the price trend for vegetables is mixed, those of cereals and pulses continue to decline, but the pace has reduced, added IDFC whose preliminary estimate for September CPI is 5.1%, after building-in a small month-on-month rise in food prices. Thankfully, easing global crude oil prices could provide some cushion to energy inflation.
But that’s not all. There is another important development that needs to be monitored and could weigh on RBI’s decision on interest rate. “The four-year term of the three external members in the monetary policy committee concludes next month and new members might be named ahead of the October rate review,” Radhika Rao, senior economist and executive director at DBS Bank, Singapore, said in a note.
Interestingly, latest RBI meeting minutes show that two of the existing external members in the Monetary Policy Committee are in favour of cuts versus the majority whose decision is to hold on rates. “Incoming members might prefer to maintain the status quo in October but follow a broader MPC shift in December as more inflation and growth prints become available,” Rao added.
The RBI has kept key policy rates unchanged for more than 18 months now.
On the global front, the European Central Bank lowered its deposit rate by 25 basis points to 3.50%, in line with expectations. Attention now turns to the US Federal Reserve, which is set to meet on 17-18 September. The Fed is expected to begin its monetary policy easing cycle with a 25 basis point rate cut. One basis point equals one-hundredth of a percentage point.
