The old saying ‘a bull in a china shop’ is often meant to signify a disruptive force in a delicate situation. In this case, it is the January CPI inflation data. The delicate situation at hand is whether the RBI will hike rates further. The RBI has already hiked policy rates by 250 basis points since last May, with the latest 25bp salvo delivered only a couple of weeks back.

Headline inflation spiked to 6.5 per cent y-o-y from 5.7 per cent in December, a sizeable 50 bp higher than what markets were expecting. Food inflation raced to 6.2 per cent from 4.6 per cent in December, with strong price pressures across a number of sub-categories. Core inflation too remained sticky, inching up to 6.2 per cent from 6.1 per cent in December.

A number of aspects of the inflation data however, seemed to perplex economists. First, cereals CPI spiked up by a steep 2.6 per cent on a month-on-month (m-o-m) basis, out of sync with daily data from local markets. Intriguingly, if one were to take the weighted average of the sub-components of the cereals basket (like rice, wheat, maize, etc.), cereals CPI should have grown by only 0.2 per cent m-o-m.

Such a divergence between the sub-components of the CPI cereals series and the overall cereals CPI index is non-trivial — even as it is true that the official compilation methodology is more complex than a simple weighted average. In our view, the difference is non-trivial enough to have caused headline inflation to be lower by 0.23 percentage points. Government sources have clarified that the discrepancy was because data were not available for all States, leading to an internal readjustment of weights.

Core inflation dynamics were also puzzling. Despite slowing industrial and export growth and falling global commodity prices, core goods inflation continues to surge. Meanwhile, despite the services-driven rebound, interestingly, core services inflation is moderating.

Despite these confounding trends, February inflation is likely to remain around January levels, while core inflation is likely to inch lower but remain sticky at around 6 per cent. However, beyond that, we expect lower headline and core inflation. Favourable base effect will play an important role — inflation rose to 7.8 per cent in April from 6.1 per cent in February 2022 and averaged 7.2 per cent in H1 FY23.

There are fundamental reasons too. Underlying core inflation is moderating on the margin, and weaker demand. Lower cost pressures should help with goods inflation, while the plateauing of services activity should limit the upside risks on services inflation. Lower global food prices mean that any incremental shock to domestic food prices may arrive due to unforeseen events (such as weather). Stable oil prices also mean that domestic fuel prices are unlikely to rise materially, lowering fuel inflation.

Overall, we expect headline and core inflation to moderate to 5.6-5.7 per cent in March, and track closer to 5 per cent from April onwards.

RBI’s reaction

The higher out turn of near-term inflation suggests an upside risk of 0.4-0.5 percentage points to the RBI’s Q4 FY23 forecast of 5.7 per cent. Consequently, the April MPC meeting remains a live one for a 25 bps hike, although our base case is still a pause (70 per cent probability). As tempting as it may be for the RBI to react to emerging inflation readings, doing so will ultimately be backward looking, especially considering the sizeable tightening already delivered. Monetary policy works with long lags, and one-year ahead real rate is tracking at above 1 per cent by our estimate. Moreover, the RBI’s FY24 forecasts for GDP growth (6.4 per cent) and CPI inflation (5.3 per cent) could turn out to be over-estimates – we expect growth and inflation at 5.3 per cent and 4.8 per cent, respectively. In our view, the lower-than-expected growth and inflation could trigger the start of a rate easing cycle from October, with 75bps in cumulative rate cuts in H2 FY24.

The writer is India Economist, Vice-President at Nomura