RBI policy: Can higher inflation become the new normal for the markets?

The upward revision in RBI's inflation projection, analysts suggest, implies that the central bank is likely to keep the rates elevated for a longer period of time than what the Street expected.

The Reserve Bank of India's (RBI's) upward revision in inflation projections triggered a knee-jerk reaction in the markets, with the S&P BSE Sensex dropping over 400 points, or 0.7 per cent, in intra-day trade to hit a low of 65,539.05.

The upward revision in the inflation projection, analysts suggest, implies that the central bank is likely to keep the rates elevated for a longer period of time than what the Street expected. This, in turn, can keep the market sentiment in check.

“The monetary policy committee (MPC) has delivered in line with market expectations on rates, stance and tone, with retention of rates and stance and the tone turning hawkish. The significant change is the upward revision in FY24 CPI inflation projection from 5.1 per cent to 5.4 per cent. This means the high policy rates will remain high for long and, therefore, a rate cut can be expected only in Q1-FY25,” said V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services.

The RBI in its review of the monetary policy revised upwards its inflation projections for financial year 2023-24 (FY24) to 5.4 per cent from the earlier forecast of 5.1 per cent. The projection for the second (Q2) and third (Q3) quarters of FY24, however, have seen a sharp revision to 6.2 per cent (5.4 per cent earlier) and 5.7 per cent (5.4 per cent earlier).

In the short-term, the higher inflation projection will become the new normal for the markets, feels U R Bhat, co-founder and director, Alphaniti Fintech, till there is a new set of data points for the markets to react to.

“The markets have already reacted to the inflation and growth projections. A lot of this now is in the price / levels and seems to be the ‘new normal'. Till the time we have new data points in terms of performance of the global and domestic economy, the markets are likely to take cognizance of the current available projections and play out accordingly. I do not see a huge downside in the markets from here on out,” Bhat said.

From its 52-week high level of 67,619.17 hit on July 20, 2023, the S&P BSE Sensex has lost over 1,900 points, or around 3 per cent till August 10. Flaring crude oil prices (Brent) – up nearly 20 per cent to over $87 a barrel now, coupled with rising food prices back home that have stoked inflation fears have dented market sentiment in the past few weeks.

The dilemmatic issue for the RBI in the run-up to the August policy meeting, according to Aurodeep Nandi, India Economist and vice-president at Nomura, was the sharp rise in vegetable and broader food prices has led to a sharp increase in the inflation outlook, which risked impacting the RBI's inflation targeting credibility if it sounded too dovish. On the other hand, the supply side nature of these shocks, and softening core inflation limits the need for monetary policy tightening in response.

The central bank's hawkish stance, said Gaurav Dua, head of capital market strategy at Sharekhan by BNP Paribas, was expected in the backdrop of global uncertainties and rising food prices back home.

“We do not see any lasting or material impact on equity markets from the policy announcement and continue to retain a positive view on markets from a medium-to-long term perspective. Any dips should be seen as an opportunity to accumulate quality stocks keeping in mind the multi-year economic upcycle in India,” Dua said.