Sharp drop in CPI inflation: Is one more rate hike in the offing?

FY23 CPI is likely to average near 6.5-6.6 per cent. In simple words, the message is crystal clear. FY23 has one more hike in store. November CPI inflation surprised on the downside led by a sharp fall in vegetable prices. However, core inflation remained elevated and sticky.

Analyst now expects average FY23 and FY24 CPI inflation at 6.6 per cent and 5.3 per cent, respectively. Accordingly, it expects the February MPC decision is likely to be finely split between a last 25 bps repo rate hike and a pause.

November CPI inflation at 5.88 per cent (October: 6.77 per cent) surprised sharply on the downside. Sequentially, headline inflation contracted by 0.1 per cent led mainly by a sharp fall in vegetable prices, and fruits.

While vegetable prices moderated, cereal prices continue to push up food inflation. However, high frequency data points to a contraction in prices of vegetables, pulses, cereals, and oils. Fuel and light inflation rose by 10.6 per cent, while moderating to 0.4 per cent mom. Rural and urban inflation moderated to 6.1 per cent and 5.7 per cent, respectively.

September core inflation remained steady at 6.3 per cent. Sequentially, however, core inflation moderated marginally to 0.4 per cent. Inflation in clothing and footwear remained high at 9.8 per cent, followed by household goods and services at 7.7 per cent, and personal care and effects at 7 per cent led again by gold and soaps. Sequentially, all miscellaneous categories registered positive growth. Rural core inflation continued to outpace urban core inflation with both remaining broadly sticky around the 6 per cent levels.

Elevated and sticky core inflation will remain a cause for concern. Analysts await the December MPC minutes for any cues on future rate actions and shift in stance. Experts continue to monitor risks from volatile crude oil prices, elevated domestic core inflation, and pass-through of input costs to prices.

With the sharp correction in food inflation unlikely to sustain at a similar pace, Icra projects the YoY inflation for December at 5.9-6.1per cent, resulting in an average CPI inflation for Q3 of 6.2 per cent, well below than the estimate pegged by the MPC for the quarter (+6.6 per cent).

Emkay sees CPI inflation around 6 per cent till February before dipping sharply to 5 per cent in March and to around 4.5 per cent in 1QFY24. The inflation trajectory is likely to be slightly below the RBI's latest estimate.

The case for a pause in the February policy itself will get stronger, especially as the next few CPI inflation prints possibly remain below 6 per cent.

However, with the focus increasing on sticky core inflation, the February policy will be a tough choice between further tightening and a prolonged pause, especially if global and domestic growth impulses start softening. The skew, for now, remains towards a last 25 bps hike followed by a prolonged pause.