Inflation: Is the Worst Over?

The last round of inflation prints have dealt an ugly blow to markets, with CPI breaching the dreaded double digit mark and even WPI climbing to the psychological 7% level. This caused sufficient panic amidst participants ultimately forcing the RBI governor to intervene and provide his interpretation on the CPI print. This wasn’t nearly as worrisome as market had made it out to be. Our own hypothesis on inflation is for the momentum to start to weaken as the 2 temporary factors of unseasonal fruits and vegetables price rise along with currency depreciation begin to roll over. The analysis below is aimed at throwing more light on the first of these temporary factors; the effect of rise in fruits and vegetable prices and the possible path ahead in this context.

 The yellow line above tracks month-on-month change in CPI. The purple line tracks the contribution of fruits and vegetables to the month-on-month change in CPI. In the last 2 years, it can be seen that the contribution of fruits and vegetables to CPI momentum has peaked in June – July and then fallen till December. Hence, there has been a seasonality to fruits and vegetables specifically and primary articles inflation generally that has led momentum on headline CPI lower as well during this period. This year, although a similar turn in momentum happened for fruits and vegetables starting June – July thereby reducing its contribution to headline CPI momentum, this fall in contribution wasn’t as severe as the past 2 years. Furthermore, in the latest October print, the contribution actually increased thereby reversing direction entirely from what has been the case in the past 2 years. Most of this is presumably accounted for by the supply disruption that has been caused owing to skewed rainfall distribution over the past few months. By the same logic now that (as media reports suggest) the supply disruption is smoothening out, fruits and vegetables should re-adopt their historic trend of falling momentum and hence falling contribution to the headline CPI. Whether the CPI momentum falls overall will also depend upon momentum on other variables. In this regard it has been heartening to see momentum in core inflation falling sharply in the October print. If this trend were to continue alongside a reversion to normal seasonality in inflation momentum for fruits and vegetable prices, it is quite likely that CPI momentum and indeed headline CPI readings begin to ease over the next couple of months. If true, this would be a major positive trigger for market sentiment especially as bond supply pressures would abate considerably once we are past November.