RBI may hike interest rate by 25-35bps in Aug meeting; Inflation likely to cool off on easing commodity prices

By Deepak Jasani

CPI inflation inched down marginally to 7.01% in June from 7.04% in May, which was broadly on expected lines. This marks the sixth consecutive month that the CPI data has breached the RBI’s upper band of 6%. Inflation in the food basket eased in June 2022 to 7.75%, compared to 7.97% in the preceding month. The CPI inflation has averaged to 7.3% in Q1FY23 which is lower than the RBI’s estimate of 7.5% for Q1FY23.

Food inflation eased to 7.75% in June from 7.97% in May, mainly on the back of tailwinds from excise duty cut (in later half of May 2022) which led to sharp decline in fuel inflation. However, higher costs for vegetables (amidst uneven monsoon), cereals and services were offset by the lower edible oil and fuel prices. Moreover, higher inflation print was seen in pan, tobacco and intoxicants, clothing and footwear, housing. Inflationary pressures continue to remain broad-based. While the CPI inflation in urban areas corrected further to 6.9% in June 2022 from 7.0% in May 2022, inflation in rural areas was steady at an elevated 7.1%, relative to the previous month. Core inflation — the non-food, non-fuel component of inflation — continues to remain sticky at 6%. 

The wholesale price-based inflation has remained in double digits for 14 months and touched a high of 15.9% in May. Rising input costs have become the primary cause for concern for the economy. The wide wedge between WPI and CPI inflation suggests there is a risk of further passage of higher input costs from firms to consumers.

Easing of commodity prices on the back of global recessionary fears coupled with sharp correction in crude oil prices is likely to ease the domestic input cost pressures, providing some respite to the core-CPI print in the near term. Monsoon and progress in Kharif sowing would be a key monitorable for food inflation trajectory. Overall the cumulative rainfall was 7% above normal till 1^st week of July which bodes well for agriculture produce. High services inflation could keep headline inflation for July-22 above 7%. However inflation could fall to ~6% in 2HFY23 due to high base and moderation in commodity prices. 

The MPC has already raised the repo rate by 90bps to 4.90% and is scheduled to meet Aug 2-4. On the basis of expected normalisation of negative real rates and to halt further currency weakening, RBI will need to continue raising rates. We expect the RBI to increase the policy rate by 25-35bps in Aug meeting and terminal rate of 5.50-5.75% by end of this fiscal. Pressure on bond yields could ease for the time being and equity investors could get some respite from this development. Any negative global shocks on inflation and interest rates could be the joker in the pack.

(Author Deepak Jasani is Head of Retail Research at HDFC securities The views expressed are the author’s own)