India Inflation At 7% Sets Stage For June Repo Rate Hike

A rise in prices of items from cooking oil to meats, clothing to recreation will likely push India's Monetary Policy Committee towards a hike in the policy repo rate in June, said economists after the March inflation print came in higher than expected.

The central bank, at its policy review on Friday, pivoted towards a focus on inflation while raising the floor on interest rates. It, however, stayed away from a hike in the repo rate.

Retail inflation at 6.95% in March may push monetary authorities to do more. India's inflation target is at 4 (+/-)2%.

"CPI inflation exceeded the RBI’s target range materially, as rising food, logistics and energy prices added to inflation," said Rahul Bajoria, chief India economist at Barclays. "We revise our CPI forecasts to 5.8% for FY22-23, and now expect four 25 basis points rate hikes from the RBI in FY23, starting from June’s MPC meeting," Bajoria wrote in a note after the inflation data.

According to Barclays' estimates, inflation will rise further in April to about 7.1%. Higher fuel prices, which were increased towards the end of March, will feed into the April consumer price inflation data.

"Food inflation could be further impacted by rising farm input costs. Core inflation could remain elevated, led by rising services inflation on the back of strong pent-up demand," said Pranjul Bhandari, chief India economist at HSBC, adding that they see FY23 inflation at 6.1% compared to the RBI's forecast of 5.7%.

"With the MPC having signaled an imminent stance change, the rate hike cycle may begin as early as June 2022, if the next CPI inflation print doesn’t significantly cool off from the March 2022 level," said Aditi Nayar, chief economist at ICRA Ltd. "We now expect to see 50-75 basis points in rate hikes by the end of Q2 FY23, followed by a pause in the second half of the year, and perhaps another 50 basis points in hikes in FY24," Nayar said.

ICRA's analysis of the March inflation data showed that along with higher prices of food items, a gradual pass-through of higher commodity prices has begun.

Markets are already building in a sharp hike in rates over the next 12 months.

The overnight indexed swaps market, a measure of market expectation of the money market rates, is signalling 100-150 basis points in rate hikes in the current cycle.

Yield on the benchmark 10-year bond has risen to nearly 7.2% on the expected monetary policy tightening.

With headline inflation rising to above 7%, policy space to remain accommodative has reduced significantly, said Gaura Sen Gupta, economist at IDFC First Bank Economic Research. "After today’s print, we see greater chances of a Repo rate hike in June policy."

Apart from the high food inflation, core inflation has remained elevated at 6.5%, Sen Gupta said, adding that higher gold prices added to this component. April CPI will likely exceed 7% as the impact of fuel prices will be felt more in the current month.

The higher inflation is coming alongside weak indicators of growth. Industrial output rose 1.7% in February compared to a year earlier but fell sequentially, reflecting a decline in consumer goods production.

"The pace of policy normalisation will need to be gradual as growth recovery is showing signs of weakness as indicated by the February IIP print," Sen Gupta said.

Nomura, however, does not see scope for gradual normalisation.

The growth recovery faces downside risks, but with the inflation out turn materially to the upside and momentum still rising, we are lifting our terminal repo rate forecast to 6% by the third quarter of 2023, said Sonal Varma, chief India economist at Nomura in a note on Wednesday.

Nomura expects 25 basis point rate hikes at each of the next eight MPC meetings starting June, adding up to a cumulative of 200 basis points. "We see elevated risk that rate hikes could be even more frontloaded, with a 50 basis point hike in one of the meetings in 2022, given that monetary policy often works with long lags."