Softer inflation trips rate hike forecasts, RBI hold more likely

MUMBAI: A softer-than-expected inflation trajectory in the first quarter has prompted economists to forecast a pause in rate action by the Reserve Bank of India (RBI), with at least two institutions that had earlier estimated an increase in policy rates at the August review meeting itself are now uncertain about the timelines for a hardening cycle.

ANZ Bank and CitiBank had pencilled in a 25-basis-point rise at the August policy meeting. Both have withdrawn that forecast after consumer inflation averaged 3.9% in April-June, compared with the RBI's forecast of 4.2%.

Standard Chartered Bank had already withdrawn its August rate hike forecast following the last policy review. ET’s interactions with bank economists and a review of research reports show that most institutions now expect the RBI to remain on hold through FY27, while some believe any rate hikes would be back-ended later in the year as the central bank prioritises growth over inflation management.


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The RBI’s rate-setting committee will meet from August 3 to August 5. The policy rate stands at 5.25%, having remained unchanged in the last three policy reviews.

The change in forecasts also comes amid moderating crude prices. The RBI has assumed an average crude oil price of $95 per barrel for FY27. This baseline was revised upward from an estimate of $85 per barrel considering volatility and rising input costs, which pushed the central bank’s FY27 inflation projection to 5.1% in June from 4.6% in April.

‘WITHIN TOLERABLE LIMITS’
“We expect December-quarter inflation to undershoot the MPC's current projections. However, risks of higher inflation could emerge if El Nino conditions turn out to be more intense than expected and/or oil prices rise further,” Anubhuti Sahay, India head of research, Standard Chartered Bank, told ET. “If inflation persists above 5.5% for a sustained period, the risk of a rate hike could re-emerge.

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According to the RBI’s projections published in June, inflation is expected to be 5.1% in Q2, 5.9% in Q3 and 5.4% in Q4. Fullyear FY27 inflation is projected at 5.1%, slightly above the central bank’s mandate of 4% but within the two percentage-point latitude offered by a flexible price stability mandate.

Some economists, however, continue to expect a cumulative 50-basis-point rate hike in FY27 due to renewed geopolitical tensions and the possibility of elevated inflation driven by higher food prices.

“Inflation data continues to trend upward, with much of the increase driven by higher food prices and a partial pass-through of the fuel price hike... We continue to expect 50 bps of rate hikes in H2 FY27,” said Upasna Bhardwaj, chief economist at Kotak Mahindra Bank.

Aditi Nayar, chief economist at ICRA Ratings, agreed that the RBI is likely to stay on hold, but said any future rate hikes would require clear evidence that inflation had moved sustainably above the central bank’s comfort levels.

“More clarity is needed on the monsoon outcome, which will only be available later in the season. Consequently, any rate hikes are likely to be back-ended in the fiscal,” she said.