To break the inflation fever, both US Fed and RBI have more work to do

As per data released Monday, India’s inflation measured by the consumer price index (CPI) reclaimed the 7%-mark in August, after declining to 6.71% in July.

The uptick was primarily led by a seasonal rise in food inflation, which accounts for nearly half of the CPI basket. With that, India’s retail inflation is remains above the central bank’s comfort zone of 2-6%. As a result, economists expect the Reserve Bank of India (RBI) to increase repo rate by another 35-50 basis points (bps) on 30 September. One basis point is 0.01%.

The RBI’s rate-setting panel raised the repo rate by 50 basis points for the third time in a row in August, taking the policy rate to pre-pandemic levels of 5.4%

Data released on Tuesday showed that in the US, the annual retail inflation rate eased to 8.3% from 8.5% in July. Even so, it remains elevated and higher than Wall Street’s consensus estimate of 8.1%. The decline in gasoline prices was offset by higher costs of food, shelter and medical care services.

Consequently, the clamour for a 100bps rate hike by the US Fed is getting louder. The US Fed is scheduled to meet 20-21 September.

“Clearly this outcome throws out any talk of the Fed potentially surprising with a 50bp hike next week, but it isn’t calamitous enough to see a big push for 100bp – at the time of writing the market is pricing 80bp, up from around 72bp before the report’s publication,” James Knightley, chief international economist, ING said in a note on 13 September.

No wonder then that global equity markets are getting nervous. In the US, the Dow Jones Industrial Average index fell over 1,000 points on Tuesday. Following suit, Asian stocks also saw a sharp decline in early deals on Wednesday.

According to Phil Segner, senior research analyst & co-portfolio manager at Leuthold, market expectation is now for a Fed funds rate of 4% by the end of the year. That’s 150bps of rate hikes – half of which is now almost certain to come next week thanks to today’s data.

“Remember early this summer when the idea of a “September pause” was batted around? Fed funds futures for December of 2023 have remained below the current year since June, meaning a rate cut, albeit at much higher levels, is expected sometime next year,” he said in a note on 13 September.

Meanwhile, analysts also note that in addition to raising short-term interest rates the US Fed has picked up the pace of its quantitative tightening programme this month. This process refers to the US Fed reducing the size of its balance sheet. Earlier this year, the Fed’s balance sheet had reached nearly $9 trillion.

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