Core inflation above tolerance band, another rate hike likely

“Headline inflation moderates due to volatile components, but underlying inflation remains sticky at about 6%, calling for further policy tightening,” Nomura said.

“We retain our view of a terminal policy rate of 6%, with a 35 basis points hike at the next meeting in September and a final 25 bps hike in December,” Nomura’s research analysts Sonal Verma and Aurodeep Nandi said.

India Ratings and Research, too, believes that the base effect would remain unfavourable till October 2022 and will continue to exert pressure on inflation.

Inflation measured by the consumer price index (CPI) eased to 6.7% in July, from 7% in June, but was primarily led by volatile components such as vegetables, edible oil, gold, silver, petrol and diesel.

Underlying inflation was unchanged at elevated levels with core CPI inflation remaining at 6%.

“This suggests that domestic demand remains strong and underlying inflation is still trending at the upper end of the RBI’s inflation target range,” said Nomura.

There is an uptick in consumer goods and capital goods output growth, signalling robust domestic demand.

“Looking ahead, high-frequency price data suggest that headline inflation is likely to remain around July levels in August,” Nomura said.

Food inflation dipped in July, but cereals inflation crossed the 6% mark after a gap on 23 months. Lower buffer stocks of wheat have been translating into higher wheat prices. Moreover, 13% lower area under paddy by the end of July 2022 compared to last year coupled with higher demand for PMGKAY is also keeping pressure on cereals, said India Ratings & Research.

“The inflation data should keep the RBI on course for further rate hikes, as underlying inflation at 6% suggests that domestic monetary conditions need to be tightened further to slow trend inflation, and to prevent the second-round effects from materialising,” said Nomura. With moderating input cost pressures on goods, but reopening effects on services and higher cereal price inflation, “we expect headline inflation to remain above 6% until February 2023, and core CPI inflation to remain sticky at a shade under 6% in the remaining months of FY23”, the firm said.