More India rate cuts seen as core inflation eases

MUMBAI: India’s headline and core inflation rates are set to converge in the coming months as the economy slows, increasing the chance of more interest rate cuts.

The core measure – which strips out volatile fuel and food costs – has remained sticky at around 6% and is a key reason economists cautioned against more rate cuts after last week’s surprise easing. It softened to 5.4% in January, and Pranjul Bhandari, chief India economist at HSBC Holdings Plc, sees it slowing to as low as 4% this year.

For now, headline inflation eased further as food prices extended their fall, albeit at a slower pace. Consumer-price growth reached 2.05% in January, well below the Reserve Bank of India’s (RBI) medium term target of 4%.

Yield on the most-traded 2028 bonds fell 8 basis points to 7.45%, while the rupee, Asia’s worst performing major currency so far this year, gained 0.2% in Mumbai.

The convergence of the two measures, along with recent surveys from the central bank suggesting slowing inflationary expectations among households and industry, will be key for a clearer assessment of policy actions by the Monetary Policy Committee (MPC). The six-member panel last week voted 4-2 to lower the key interest rate.

Shaktikanta Das, the RBI’s new governor, voted for a cut despite only weeks earlier acknowledging the challenges posed by the divergent paths taken by core and food inflation.

Viral Acharya, the RBI’s deputy governor in charge of monetary policy who was among those who sought to keep rates unchanged, has in the past pointed to core inflation as being a more reliable indicator.

“The reason why the split matters is because food tends to be more volatile, the core inflation tends to be more persistent,” Acharya told reporters Feb 7, referring to the divergence.

Those differences may disappear as slowing economic activity is set to drag core inflation down and also as the pass through impact from food and fuel prices fades. The MPC flagged that the output gap – the difference between an economy’s actual output and its potential – has opened up.

With the central bank now forecasting headline inflation to remain within its medium-term target for the next 10 months, chances are the two measures may converge.”