February’s retail inflation rate of 6.44 per cent, like January’s 6.5 per cent, is way out of line with the Reserve Bank of India’s expectations. In its February 8 bulletin, the Monetary Policy Committee had projected an inflation rate of 5.7 per cent for Q4 of FY23. Sustained inflation can hurt growth in FY24 by dampening demand and investment. It seems all the more likely that the MPC will hike rates in April in a bid to anchor inflationary expectations, manifested in non-fuel, non-food or ‘core’ inflation. This ‘second order effect’ of cost-push inflation has gained ground since the second half of this fiscal.

The current price run is generalised, spanning food items, household goods and services. Cereals (16.7 per cent), spices (20.2 per cent), prepared meals and snacks (7.98 per cent), clothing (8.67 per cent), fuel and light (9.9 per cent), household services (7.35 per cent), health (6.5 per cent), education (5.62 per cent) and personal care (9.43 per cent) have been major drivers of inflation. A medley of factors appear to be at work. In the case of some services and recreation, there is a demand pull component, as the price remains sticky in keeping with the consumer perception that will remain high. Meanwhile, the latest factory output data for January 2023 points to a correlation between falling output and rising prices in some sectors. For instance, textiles, apparel and leather have posted a negative output in January of minus 11 per cent (minus 8.7 per cent in April-January), minus 22.3 per cent (minus 2.8 per cent in 10 months of this fiscal) and minus 0.4 per cent (minus 5.2 per cent till January), respectively, which could perhaps be linked to retail inflation in footwear and clothing being at close to 9 per cent. Negative output is a feature of computers, electronics, transport, fabricated metals and furniture as well, which coincides with high inflation in household and other services.

However, it is not clear what is causing the output drop: whether it is high input costs; or expectations of inflation eroding demand and raising production costs directly, or through rate hikes. With wholesale price inflation now at below 4 per cent (and less for food items), albeit on a high double digit base, it is not clear how input price effects are playing out. Be that as it may, the gap between CPI and WPI readings suggests that services, which are not part of the latter, are a major price driver.

Meanwhile, the RBI’s household inflation expectations survey conducted in January says households expect a rise in inflation over the next three months. This gives rise to the question of whether rate hikes alone can quell inflationary expectations. That said, the Fed has surprised central banks with its hawkish tone. The MPC will surprise none if it raises rates in April. But there could be a point after which higher rates hurt growth, and perhaps even raise liquidity and solvency concerns.