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Inflation set to breach 6% limit today as rising oil price is the new threat

Oil rose above $70 a barrel last week amid US-Iran tensions, and while they’ve since eased, prices remain elevated compared to last year.

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New Delhi/Mumbai: Rising oil prices add a new risk to already surging inflation in India, clouding the outlook for monetary policy and threatening a nascent rally in sovereign bonds.

Oil briefly rose above $70 a barrel last week for the first time since September amid U.S.-Iran tensions, and while they’ve since eased, prices remain elevated compared to last year. In India, the world’s third-biggest oil importer, costs of everything from food to medicines and mobile-phone services have already been climbing.

Data on Monday will probably show inflation breached the upper end of the Reserve Bank of India’s 2%-6% target band for the first time since July 2016. Price-growth probably accelerated to 6.7% in December from 5.5% in the previous month, according to the median estimate of 36 economists surveyed by Bloomberg.

The RBI cited “much higher than expected” inflation when it unexpectedly kept interest rates unchanged in December following five cuts totaling 135 basis points earlier in the year.

Inflation of 6%-plus “would almost certainly bring an end to the RBI’s easing cycle”, said Shilan Shah, senior India economist at Capital Economics Ltd. in Singapore. “A rise in core inflation over the coming quarters should prompt the central bank to switch to a tightening mode much sooner than is generally expected.”

Core CPI, which strips out volatile food and fuel prices, has been subdued so far, reaching 3.5% in November.

Price stability is the central bank’s prime objective as persistently high inflation disproportionately affects the poor, Governor Shaktikanta Das said last week. That’s a more cautious tone than his comments in December, when he said the central bank will maintain an easing bias for “as long as it is necessary” to revive economic growth.

What Bloomberg’s Economists Say

“The inflation path ahead is highly uncertain as the food supply shock abates while the fresh oil and gold price shock emerges due to rising geopolitical risks.

“The RBI is unlikely to resume easing until after the surge in inflation starts to reverse in February and fall back below the 6% upper end of its target band.”

— Abhishek Gupta, India economist

The central bank will make its next interest rate decision on Feb. 6, days after Finance Minister Nirmala Sitharaman is scheduled to deliver a budget speech. With limited room for more central bank easing, all eyes are on the government to take steps to boost growth from 5% this fiscal year, the slowest pace in more than a decade.

The spike in inflation and expectations of fiscal slippage are weighing on the outlook for Indian sovereign bonds. For now though, sentiment is being buoyed by the RBI’s Operation Twist, in which the central bank has bought longer-maturity bonds and sold shorter-term ones.

The yield on benchmark 10-year government bonds has declined by more than 20 basis points since Operation Twist was announced in mid-December.

“The next few weeks are going to be a bit choppy for bonds,” said Sandeep Bagla, an associate director at Trust Capital Services India in Mumbai. “I don’t see any great joy on the face of increasing headline inflation.” – Bloomberg

Also read: 5.5% inflation is transitory, it shouldn’t prevent a fiscal boost in Budget 2020


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