Higher inflation unlikely to deter MPC from further rate cuts

Higher inflation is unlikely to deter the Monetary Policy Committee (MPC) to hold any further rate that has become important to infuse liquidity and prop up economic activity dented by Covid-19 pandemic.

According to analysts, an additional 25-35 bps of repo rate cuts could be expected from the MPC given the sharp deceleration in growth when it meets next to take stock of the situation and recommend monetary actions. Further action remains contingent on the evolution of the growth-inflation mix, Kotak Institutional Equities said in a report.

The MPC decision on further rate cuts to prop up growth would, however, be weighted against a still high CPI inflation that remains above the MPC's upper limit of 6 per cent. But much of inflation is on account of higher fuel and gold prices while food inflation has started to normalize with the easing of supply disruptions.

With inflation expected to moderate below 4 per cent in 2HFY21, we continue to expect additional 25-35 bps of repo rate cuts given the sharp deceleration in growth and to address the issue of demand shock, the brokerage said in its report on the state of the economy.

Along with rate cut, other liquidity and regulatory measures can also be expected from the MPC to address any financial sector dislocations, the report said.

But with MPC front loading the repo rate cuts in anticipation of benign inflation trajectory in 2HFY21, scope for further aggressive rate cuts may be limited and would depend on the evolution of growth and inflation.

June CPI inflation moderated to 6.09 per cent as against 6.27 per cent in May amid favorable base effects despite increasing momentum.

The softening was led by lower food inflation of 7.9 per cent (9.2 per cent in May) owing to moderation observed across vegetables (1.9 per cent from 5.5 per cent in May), fruits ((-)0.7 per cent from 2 per cent in May), and sugar and confectionary (4.4 per cent from 6 per cent in May) (Exhibit 2).

Price of pulses, milk and eggs remain firm, even though the pace is somewhat moderate. Meanwhile, fuel and light inflation rose to 2.7 per cent (1.6 per cent in May)..