Inflation not tamed yet, retail prices likely to stay elevated as oil prices remain sticky

By Joseph Thomas

The retail inflation touched a high of 7.79% in April and eased to 7.04% in May, showing some signs of fatigue after a five-month unbroken upward trajectory. The moderation in the prices of certain food articles helped this improvement. Food inflation came down from 8.31% to 7.97%, and components of the food basket like eggs, fruits, vegetables, and pulses were notable by their price fall. 

The inflationary pressures are expected to remain elevated over the near to medium term due to the same reasons why they moved up. The oil prices may remain sticky, as there is no immediate respite in sight from the geopolitical concerns, and therefore, the premium which has been there on the price may be retained by the markets, whether it is US$ 5 or US$ 10 for some more time. Oil prices may not be able to trade much lower as the global oil demand is close to the pre-pandemic levels, and the prospects of any substantial enhancement in production and supplies from OPEC plus remain elusive.

The trajectory of the US$ is something that could completely change the scenario and make things stand on its head. The Dollar Index is at 107.50, and it looks set to rise further owing to two reasons. The US interest rates are rising, and the Fed is aggressively positioned on the rates front to slay the demon of inflation. Second, the asset demand for US Dollars is set to rise in the coming months, and it may accelerate if some signs of a slowdown in economic activity surface. Nothing has supported lower oil prices as much as a strong Dollar. This is true of all commodities that are quoted in US Dollars. If the strength of the Dollar is going to get reflected in oil prices at some point in time, then the oil prices could be much lower. The prospects of the economic slowdown may still pull down the demand conditions for oil, but that will be clear only as we get fresh economic data in this connection. 

Yet another crucial factor would be the trajectory of food prices; the food and beverages component represents close to 46% of the domestic CPI. Against this background, the temporal and spatial distribution of monsoon assumes greater importance, this would be of import to keep food prices in check. The crop of fruits and vegetables after a good monsoon is often plenty and it keeps high prices at bay at least for some time. The RBI is firmly focusing on its inflation-targeting mandate as against the growth-supporting stance that it had adopted during the pandemic period. The policy rates may be headed higher, but the intensity of the hikes would be solely determined by the central bank’s assessment of the risks to inflation. 

The quantum of rate hikes would also be dependent on the implicit optimum trade-off between growth and inflation which the policymakers would choose to adopt. From an investment or portfolio perspective, the rates may be headed higher, though the quantum may be lower compared to the last two policy pronouncements. While it is still advisable to stay at the short end, the saturation in long-end rates may soon arrive as the market tests higher yields with a large government borrowing program that has to run right through the year.

(Joseph Thomas si the Head of Research at Emkay Wealth Management. Views expressed are the author’s own.)