Inflation risk has peaked in Asia; rate hikes may moderate: Morgan Stanley

Inflation risk in Asian economies, including India, have peaked and in the next few months, it could, in fact, surprise on the downside, said analysts at Morgan Stanley. The markets, they said, are pricing in more hawkish Asian central bank moves than warranted.

"Deflating goods demand, easing supply-chain disruptions and falling commodity prices means that goods inflation has decisively peaked. Global food prices, which was earlier a cause of concern for Asia given food’s large weightage in CPI, have rolled over meaningfully, alleviating the upward pressures on inflation," wrote Chetan Ahya, chief Asia economist at Morgan Stanley said in a recent co-authored note.

Services inflation, however, could stay firm as economies reap the fuller benefits from reopening, Morgan Stanley cautioned. But as growth is slowing, it will lead to weaker job gains, capping wage growth.

"For India, higher oil, food and core goods prices were the key concerns, while labour market conditions are fairly benign. In this regard, with commodity prices falling the way they have, the upside risks to inflation have also reduced," Ahya said.

Inflation as measured by the CPI index stood at 7.04 in May 2022, higher than the Reserve Bank of India's (RBI's) comfort zone of 2 - 6 per cent. In June, the RBI's monetary policy committee (MPC) had pegged the average headline retail inflation at 6.7 per cent for the fiscal 2022-23 (FY23), sharply higher than 5.7 per cent it had projected earlier.

While Asian economies have managed food demand-supply dynamics better and food inflation pressures are more moderate compared to other parts of the world, Ahya believes they have nonetheless partly reflected some spillover effects from the pass-through from higher global food prices.

"But with global prices of foodgrains such as wheat and fertilisers having declined sharply, by close to 30 per cent, the inflationary impulses are also set to reverse," Morgan Stanley said.

Those at Barclays, however, expect CPI in June to remain elevated at around 7 per cent as the government's measures to cap the upside will impact with a lag. That said, the recent correction in global commodity prices eventually could offer some relief, given the recent decline in prices of several commodities, including edible oils, LPG and fertilisers.

"We expect CPI inflation to remain elevated, at 7 per cent y-o-y, in June, as several factors offset each other. Imported inflation remains the key driver of higher prices, but we expect tax cuts, RBI rate hikes and signs of stabilising food prices to anchor inflation in coming months," said Rahul Bajoria, MD & Chief India Economist at Barclays.

So, what does this mean for interest rate hikes?

Ahya of Morgan Stanley believes that the markets are currently pricing a more hawkish stance than what's needed. With growth concerns now coming to the fore and perhaps taking some precedence over inflation risks, he thinks the risks that central banks in the region will have to go deeply into restrictive territory as implied by market pricing have reduced.

"Considering this backdrop, where growth concerns are entering the mix with reducing inflation upside risks, we think that central banks will not need to take interest rates as much into restrictive territory as implied by markets pricing," Ahya said.