Inflation at a multi-decade high globally, but India far better placed
Inflation globally have risen significantly higher in last few years and is hovering at multi decade highs across most global markets.
The latest print for U.S. CPI inflation reinforced the global inflationary concerns. US CPI inflation for the month of August came at 8.3% versus market expectation of around 8.1%. The month on month inflation as well as core CPI inflation both came in at higher than expectation. The elevated inflation has risen market expectation of continuous rate hike by Federal Reserve with consensus expectation of 75bps rate hike in its September 21st meeting.
From a medium term perspective, average CPI Inflation is expected to come down from 7.5% in 2022 to 3.2% in 2023 and to 2.5% in 2024 (Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters). The market consensus is that U.S. Federal reserve will hike rate by 75bps in its 20th-21st September meeting. So while US fed is adopting an inflation focused approach, sometime next year, they have to start focusing on growth as well. The probability of US going into recession in the next 12 month is around 50% and in the next 24 months is around 65. In fact, there is an expectation of a 1 rate cut in the year 2023.
The priority of US Fed may therefore change quickly if inflation falls more than expected. The debt market is also suggesting the same with yield curve being inverted since July 2022 with spread of 2-year over 10-year at one time in August being more than 40bps.
From a medium term perspective, interest rate cycle is likely to be shallow. We are not going to witness a 4-5 year cycle of rate hikes and then staying at higher levels for longer. Global commodity prices may fall as quickly as they have risen and we have already seen the glimpses of the same (crude oil falling from USD 120 to less USD 90).
In India, CPI inflation for the month of August 2022 came in higher at 7.0% as compared to market expectation of around 6.8%-6.9% and as compared to 6.7% in July 2022. The rise in inflation was led by food inflation with CFPI (Consumer Food Price Index) rising to 7.6% in August from 6.7% in July. However, over the next year inflation is expected to be at 5.0% in Apr-June quarter as per RBI projections. Therefore, the pressure of hiking rates in India is far lower than in U.S. or other major countries. In India, RBI is expected to hike rate by 30-50bps in its September 30th meeting. However, the total rate hike expected going forward is around 60bps which will take current Repo rate from 5.4% to 6.0%. Going ahead, impact on equity markets in India due to higher rates led by inflation will be limited compared to other global equity markets.
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