As inflation rises, RBI may hike repo rate by 25 bps in June: SBI report

With the Reserve Bank of India prioritising inflation over growth, the repo rate is likely to be hiked by at least 25 basis points in June, SBI's Ecowrap report said on Wednesday.

In its monetary policy announced last week, the RBI had left the repo rate unchanged at 4 per cent. The six-member monetary panel also decided to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.

"We now expect a 25 basis point (bps) rate hike each in June and August, with a cumulative rate hike of 75 basis points in the (interest rate hardening) cycle," the report said on Wednesday.

Retail inflation, as measured by Consumer Price-based Index (CPI), surged to 6.95 per cent on yearly basis in March 2022 as compared to 6.07 per cent in February 2022 mainly on account of spiralling food prices.

The Russia-Ukraine conflict has significantly impacted the trajectory of inflation.

The March 2022 inflation print shows wheat, protein items (chicken in particular), milk, refined oil, potato, chillies, kerosene, firewood, gold and LPG contributing to the overall inflation in a substantive manner.

The conflict has pushed up prices of chicken abruptly as chicken feed imports from Ukraine are getting disrupted. The pressure on sunflower oil supplies from Ukraine has led to changes in export policy from Indonesia, thereby leading to lower palm oil imports, the report said.

There was a huge gap between WPI and CPI food inflation with WPI food prices being higher than CPI food prices, which indicated incomplete pass through of prices. The gap was 4.7 per cent in January 2022 and it has now reduced to 2.3 per cent.

"We have already taken the impact of this pass through of WPI food inflation to CPI food inflation while estimating our average CPI of 5.5-6 per cent (oil price of USD 95-USD 100 per barrel)," the report said.

The report's estimates show that one per cent increase in the Minimum Support Price (MSP) leads to a rise of four basis points in CPI inflation.

"Thus, overall higher MSP should lead to upside risk to CPI inflation of 48-60 bps over our earlier inflation forecast of 5.8 per cent. Thus, taking the impact of MSP on inflation, CPI inflation could be pushed above 6 per cent in FY23. This is higher than RBI inflation at 5.7 per cent," the report said.

Inflation prints are now likely to stay higher than 7 per cent till September, it said, adding that beyond September, inflation prints could hover in the range of 6.5-7 per cent.

"Our FY23 inflation forecast is now closer to 6.5 per cent, taking into account the possibility of an extended food price shock," the report said.

It further said given that the spread between G-sec (Government Securities) yields and repo rate jumps in an increasing interest rate cycle, G-Sec yields could touch 7.75 per cent by September.

"We believe, RBI will keep the G-Sec yields capped at 7.5 per cent through unconventional policy measures," it said.