Retail inflation hits 1-year low at 5.72% but core inflation still high

There was some encouraging news on the consumer inflation front for the month of December 2022. Of course, for the 39th month in succession, the CPI inflation stayed above the median RBI expectation of 4%. However, December also was the second month in succession when the CPI inflation stayed under the outer limit of 6%. Surely, the RBI now has less to answer to the government on the inflation front. CPI inflation was 5.88% for November and has now fallen further to 5.72% in December 202. The data was released on Thursday by the Ministry of Statistics and Programme Implementation (MOSPI), which is affiliated to the Ministry of Finance.

The good news is that CPI inflation at 5.72% is also below the consensus estimates for inflation with most of the agencies like Reuters and Bloomberg pegging inflation for the month of December at closer to 5.9%. It may be recollected that the RBI has set a range of 2% to 6% for inflation with the targeted inflation median rate at 4%. The fall in inflation in the month of December 2022 was largely triggered by a fall in the price of food items. In fact, food inflation has fallen sharply to 4.19%, which is the lowest level in the last one year. Within the food basket, the overall pressure came from vegetables inflation which contracted by -15% in the quarter. Vegetable has a high weightage in food inflation.

However, if you look at the food basket closely, there was a spike in some of the high protein items like cereals, meat, milk, eggs etc. The good news is that the food inflation and fuel inflation have both tapered on a yoy basis, even as core inflation remains elevated at higher levels. That has been a concern, especially since core inflation happens to be more sticky compared to either food inflation or fuel inflation. Normally, when the RBI targets rates based on inflation, it looks closely at core inflation instead of just headline inflation. It gives a good idea of structural inflation and for the month of December 2022, the core inflation has remained above the 6% mark.

The weak Kharif has pushed up price of cereals consistently higher. This is despite the promise of a better than expected Rabi output due to overflowing reservoirs and delayed monsoons this year. However, it was not just food and fuel that showed tapering of inflation. Even housing was a pleasant surprise falling 0.6% on a sequential MOM basis. In fact, this marks the first time in the last six months that the index for housing has declined sequentially. If you leave out housing, then the inflation for clothing and footwear, continued to be high. These factors played a role in pushing up core inflation to above the 6% mark for the month of December 2022.

What does this mean for the RBI monetary stance? RBI has already guided that it would slow on rate hikes but may still consider another 50 bps rate hike from these levels. That would take the repo rates to around 6.75%, a full 160 basis points above the pre COVID levels of interest rates. RBI may take a break in February policy but another 50 bps still looks on the cards in the first half of 2023. That would ensure that the yields on Indian bonds are competitive enough to avoid any major outflows of FPIs from India.