Big rate hikes to be the global norm as inflation remains a challenge

On June 8, the six-member Monetary Policy Committee of the Reserve Bank of India unanimously decided to raise the repo rate by 50 basis points. This followed an off-cycle rate hike of 40 basis points, taking the overall rate hike to 90 bps rate hike in just a span of a little over a month, as inflation emerged as the biggest challenge facing central banks and governments around the world.

Days later, on June 16, The United States Federal Reserve raised its own interest rates by 75 bps, the biggest rate hike since 1994. The same day, The Bank of England on Thursday hiked its main interest rate for a fifth straight time, as it forecast British inflation to soar further this year to above 11 percent.

Back home, the Reserve Bank of India raised the CPI inflation projection for the year to 6.7 per cent, with Q1 at 7.5 per cent; Q2 at 7.4 per cent; Q3 at 6.2 per cent and Q4 at 5.8 per cent. The MPC noted that inflation is likely to remain above the upper tolerance band of six per cent through the first three quarters of FY23.

With no end in sight to Russia’s invasion of Ukraine, commodity prices remain elevated and supply chains remain disrupted. Oil prices edged up on Tuesday on high summer fuel demand while supplies remained tight because of sanctions on Russian oil after its invasion of Ukraine, news agency Reuters reported.

Brent crude futures settled 52 cents, or 0.5 per cent, higher at $114.65 a barrel. The US West Texas Intermediate (WTI) crude contract for July expired on Tuesday, closing at $110.65, with a gain of $1.09, or one per cent.

Big rate hikes ahead

Economists say such big rate hikes, as seen in the past few weeks, could be par for the course going ahead.

“Unless the June 2022 CPI inflation accelerates considerably from the May 2022 print, the average inflation for Q1 FY2023 could undershoot the MPC's forecast of 7.5 percent for this quarter, assuaging fears of sharp tightening in the August 2022 review. We maintain our view that the MPC will increase the policy rate by 35 bps and 25 bps, respectively, in the next two policy reviews, followed by a pause,” said Aditi Nayar, Chief Economist with ICRA Ltd.

This would make it a 65 bps hike in two rate cycles, and 155 bps for the fiscal year.

Headline retail inflation for the month of cooled from the eight-year high in April and came in at 7.04 per cent on the back of the base effect and cheaper food prices. It was still the fifth straight month of CPI inflation being above the MPC’s medium-term target of 4 (+/-2) per cent, thus justifying the two recent interest rate hikes by the central bank.

“We are expecting that RBI could factor in rate hike in Aug’22 and even in October policy, and take it higher than pre-pandemic level by October to 5.5 percent. Our peak rate at the end of the cycle now has now a higher probability of a lower bound of 5.5 percent and a lower probability of going up to 5.75 percent depending on inflation trajectory,” said Soumya Kanti Ghosh, Chief Economic Advisor, State Bank of India.

Missing target now a given

It is now a given that CPI inflation for FY23 will breach the MPC’s upper tolerance limit of 6 percent, with many analysts expecting inflation to even be above the 7 percent range.

Many commentators have pointed out that the Reserve Bank should have gone for a rate hike in its April policy meeting itself, when the war was still on and inflationary pressures were rising. This could have removed the need of the off-cycle need in May.

The matter even became political, with the opposition Congress party accusing the RBI of being behind the inflation curve.

In a recent article in Indian Express, former Chief Economic Advisor Arvind Subramanian said that although retail inflation had been above the mid-point 4 percent target since October 2019, and above 6 percent for 18 of those 32 months. “If the US Fed and the European Central Bank have been behind the curve for about a year, the RBI has been behind, for longer. Even now, it is not leaning hard against inflation.

Former RBI Governor Raghuram Rajan had also said in March and April that the RBI will have to recaliberate its stance and raise rates.