Inflation Surges, Could Invite Policy Action

The CPI based inflation stayed above RBI’s target range of 2% to 6% for the third consecutive month and touched a 17-month high. The headline inflation for the month of Mar’22 came in at 6.95% as compared to 6.07% in the preceding month, and 5.52% during the year ago period. The surge in inflation was broad based with most of the sub-components reporting enhanced price pressures. The core inflation too moved higher and breached the 6% mark.

The Consumer Food Price (CFP) inflation witnessed a spike to 7.68% for the month of Mar’22 as compared to 5.85% for the month of Feb’22. The CFP inflation moved higher by 1.40% on a MoM basis for Mar’22, a reversal from the contractionary MoM trend for the preceding 3 months. The components of the food basket that reported firming-up of inflationary pressures were Meat & Fish, Oils & Fats, Vegetables and Spices. Along with the effects of seasonal pressures, the second-round effect of hike in fuel prices on transportation costs are expected to keep food inflation elevated. The inflation for Clothing, Fuel & Light, Housing and Miscellaneous was reported at 9.40%, 7.52%, 3.38% and 7.02% respectively.


The movement in oil prices over the recent past have largely been a function of the news flow pertaining to the Russia-Ukraine war. The oil prices had started moving higher in 2021 as the demand recovered to pre-covid levels but the capacity of OPEC+ to increase supplies remained limited. The adverse geopolitical development involving one of the key energy producers exacerbated the momentum of the underlying trend in oil prices. The continuing supply of Russian oil & gas, and impact on demand due to fresh lockdowns in China owing to the resurgence of pandemic in that region has led some cooling-off in oil prices. The risks of further sanctions on Russia pertaining to its oil supply is the key risk at the current juncture that may lead to renewed pressure on oil prices.


The core inflation (ex food and fuel) that had remained largely stable around the 6% mark for the past few months moved higher as the price pressures turned broad based. The core inflation came in at 6.32% for the month of Mar’22 as against 5.99% for the preceding month. All the sub-components of Miscellaneous segment, except for education, reported inflation upwards of the 6% mark. The second-round effects of rise in oil prices coupled with the gradual pass through of input costs by manufacturers are expected to keep core inflation elevated over the near term.


The surge in inflation and the expectations that it may remain elevated and outside the RBI’s target range for an extended period, may lead to MPC turning its focus firmly towards inflation control earlier than expected. The policy stance may shift, as early as, in Jun’22 policy and may also be accompanied by a rate action if the inflation numbers for the intervening months continue to remain elevated. The outcome of the recently concluded MPC meeting wherein it was decided to raise the reverse repo rate by 40bps, gave an indication that addressing inflationary risks may find precedence over supporting growth.
Post the policy announcement, the market participants expect the policy rates to be hiked by 75-100bps in FY23. The spread of 10yr gsec yield over repo rate may indicate that the rate hikes may be priced-in but the incoming inflation numbers and the actual rate hikes may keep the yields volatile with an upward bias. Investors would be advised to avoid duration calls and maintain investments at the shorter end of the yield curve.


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