Inflation at 8-yr high, will RBI go for another round of rate hike?

The shooting up of CPI inflation to a 95 month (about 8 years) high at 7.8 per cent in April makes it a strong point for the MPC to hike key policy rates further in the forthcoming policy review in June, after already having raised the rates in May. Though, the quantum of hike is yet to be known. However, possible increase in the repo rate by 35-40 basis point in the ensuing policy review can be anybody's guess.

Of course, the jump in CPI inflation in the month just gone by was due to a sharp but expected spike in food inflation pushing up the headline figure, even as core inflation printed at a rather unpleasant level. The negative surprise was largely on account of miscellaneous items, fuel and light, and clothing and footwear, raising the spectre of a generalisation of inflationary pressures.

Again, the surge in the CPI inflation has clearly justified the off cycle rate hike on the eve of the Fed's rate hike significantly raised the likelihood of a back-to-back rate increase next month. Interestingly, rural inflation continued to outpace urban inflation for the fourth consecutive month and will add to the concerns on rural demand.

Icra now foresees a high likelihood that the MPC will raise the repo rate by 40 bps and 35 bps, respectively, over the next two policies to 5.15 per cent, followed by a pause to assess the impact of growth. As of now, it continues to see the terminal rate at 5.5 per cent by the middle of 2023.

Analysts do see June's policy to be super-live, and the MPC may front-load rates by another 25bps-40bps. The terminal rate may be around or a tad higher than 5.50 per cent, with the RBI now showing its intent to keep real rates neutral or above.

Overall rising price pressures remain a cause of concern, and are likely to pressure MPC further. The triple whammy of commodity-price shocks, supply-chain shocks and resilient growth, has shifted the reaction function in favour of inflation containment.

The RBI, as per Emkay, no longer thinks the output sacrifice required to tame somewhat supply-driven inflation can be so high on net. The RBI's reaction function is now evolving with fluid macro realities.

Over the next few months we should be focusing on movement in edible oils, crude prices and fuel price hikes, Kharif MSP announcement, and pass-through of input prices by the companies to glean on the inflation trajectory. On the monetary policy front, Kotak expects the RBI to hike repo rate by 35-40 bps along with 50 bps hike in CRR. In the current calendar year, from hereon, the analysts expect repo rate hikes of 90-110 bps along with 50 bps of CRR hike. The RBI would aim to reduce liquidity along with reverting to above 5.15 per cent level of repo rate as soon as possible.