Over the past 12 to 18 months, one thing that has worried investors is high inflation and high interest rates that have followed. In recent monetary policy committee meetings, the Reserve Bank of India Governor Shaktikanta Das has been stressing that the focus is on aligning retail inflation to the 4 per cent target and not the 2 per cent to 6 per cent band.
In this backdrop, CPI (consumer price index) inflation figures released this week for October should bring some relief. October CPI came in at 4.87 per cent, a four-month low. It had been at 5.02 per cent in September. Not just in India, even in the United States inflation is cooling. US consumer price index grew 3.2 per cent last month, down from 3.7 per cent in September.
Not surprisingly then, equity markets have rallied hoping that the end of monetary policy tightening may be near. The Dow Jones Industrial Average and S&P 500 index gained 1.4 per cent and 1.9 per cent overnight. Major Asian indices like Japan's Nikkei 225 and Hang Seng in Hong Kong surged 2.5 per cent and 3.75 per cent respectively. That enthusiasm reverberated in domestic markets too. Both BSE Sensex and NSE Nifty 50 were up over 1 per cent in afternoon trading on Wednesday.
After peaking at 7.4 per cent in July 2023, retail inflation in India has been on a downward trajectory. A correction in vegetable prices, government measures like reducing domestic LPG prices and continued fall in core inflation on the back of significant easing in clothing and footwear and few other components in the services category are among the reasons behind the cooling inflation.
So, is it really time to rejoice? Are the tighter interest rates a thing of the past? And will central banks, including the RBI, cut rates soon? Analysts feel that may be too early. Importantly, they warn that the cooling vegetable prices may not be sustained in coming months given the climate-related uncertainties and lower agricultural output.
"The declining trend in the headline as well as core inflation is comforting. However, it remains to be seen if it sustains, given the weak prospects for the Kharif harvest and the expected hit to Rabi sowing amid lower reservoir levels in major agricultural states," said Rajani Sinha, chief economist at CARE Ratings.
Categories like pulses and cereals have already witnessed sticky double-digit inflation and the first advance estimate of Kharif crop production paints a grim picture, Sinha pointed out.
The credit ratings agency expects CPI inflation to remain range-bound around 5.3 per cent to 5.4 per cent in the next two quarters, even as it has reduced its full year ending March 2024 inflation expectations slightly to 5.4 per cent from 5.6 per cent.
"With risks tilted to the upside, the RBI is expected to remain vigilant and maintain its hawkish policy tone in the upcoming policy meeting. Any monetary policy change can be expected only in the second quarter of FY25, when CPI inflation moves closer to the RBI's 4 per cent medium-term target," said Sinha.
According to Sonal Varma, chief economist - India and Asia ex-Japan at Nomura Securities, high frequency data suggests headline inflation is tracking higher at 5.8 per cent year-on-year in November, due to higher onion prices, but core inflation should remain anchored at around 4.3 per cent.
Nomura expects India's headline inflation to average 5.3 per cent in the current financial year and 4.4 per cent, close to the RBI's projections, in FY2025. It also doesn't see RBI monetary policy easing anytime soon.
"Lower core inflation should ensure an extended policy rate pause, but intermittent food price shocks risk endangering inflation expectations, and may prompt the RBI to keep liquidity tight through OMO (open market operations) sales," said Varma.
Their base case scenario envisages policy easing starting April 2024, but recurrent food price shocks may risk a delay, she added.
Prasenjit Basu, chief economist at ICICI Securities, expects headline inflation to ease to 3.8 per cent by March 2024, which will allow the Reserve Bank to cut the repo rate by 25 basis points at its first meeting of 2024-25 in April. This should give a fillip to the economy, enabling it to accelerate to 8 per cent real GDP growth in FY25, he felt.
Over in the US, economists also remain diverged on when the Federal Reserve will cut interest rates and how fast will the rates slide downwards.
Goldman Sachs, for instance, sees the first 25 bps rate reduction by the Fed only in the December quarter of 2024. This will be followed by one cut each quarter through mid-2026. In all, Goldman Sachs sees a cumulative 175 bps rate cut by the Fed, with interest rates settling in the 3.50-3.75 per cent range.
On the other hand, Morgan Stanley expects the Fed to start cutting rates in June 2024 itself, followed by another cut in September and then a 25 bps cut each in every meeting from the December quarter. This should take the policy rate down to 2.375 per cent by the end of 2025.
Generally, inflation is expected to ease in major markets, including India. But as noted, geopolitical tensions, crude oil moves, uncertain weather impacting farm output could yet play a spoil sport, keeping central banks watchful.
Cooling inflation may have lifted investors' mood and raised their expectations of interest rate cuts. But in reality, they will have to wait for a few more quarters before central banks actually begin easing monetary policies.