RBI Monetary Policy Meet: Pause for now, but not the end of the easing cycle, says Edelweiss

RBI Monetary Policy Meet: The RBI had refrained from cutting policy rates at its previous monetary policy meeting, citing discomfort on elevated inflation. Inflation has been sticky since and a much-anticipated reversal in food spike has eluded so far. Edelweiss, hence, expects the RBI to maintain the status quo on rates at its forthcoming policy review on 4 th December, as it awaits a more sizeable and durable fall in headline inflation. A potential pause on rates, though, is not necessarily the end of the rate-cutting cycle. Edelweiss expects inflation to ease towards 5% or below over the next few months, and this should facilitate 25–50bps of rate cuts. The RBI itself has hinted that there is room for further rate cuts once inflation eases.

Inflation remains sticky at elevated levels:

CPI inflation has remained above 6% for seven consequent months now, with the preceding two months’ print breaching 7%: clearly outside the RBI’s tolerance zone of 4% (+/- 2%). This latter is attributable to high food inflation, which has proved to be stickier than initially anticipated.

It is important to understand the disconnect between wholesale and retail food inflation is noteworthy. The WPI agricultural inflation is hovering in a 2–3% range for the last few months while the CPI food inflation has ranged between 8 to 10%. Meanwhile, core inflation has been largely stable, although it should have eased given poor demand conditions. What perhaps hampered the easing of core inflation is cost-push/regulatory factors such as the hike in fuel taxes, rise in import duties, and hikes in telecom tariffs.

Status quo on rates in upcoming policy review:

At its last monetary policy meeting, the Monetary Policy Committee (MPC) eschewed cutting rates citing concerns around elevated inflation. Subsequent inflation readings too did not offer any comfort, with CPI still hovering above 7% essentially led by food. Hence, we do not expect a rate cut in the forthcoming policy review. The RBI would await a more durable fall in inflation before acting on interest rates.

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Outlook:

Pause for now, but not the end of the easing cycle while we expect a status quo at the upcoming policy meeting, Edelweiss believes that the RBI may not be done with the rate cuts yet. In fact, we expect another 25–50bps easing in 2021 as inflation starts to come off. There are early signs that the spike in vegetable prices is beginning to reverse, and we expect headline CPI inflation to ease towards 5% or below over the next few months. The MPC has been hinting that the room for policy accommodation will open up once there is a durable fall in the inflation trajectory. After all, while economic data has bounced back on the whole over the last couple of months, the economic activity remains far below potential and will take time to recover lost ground.