Image used for illustrative purposes only.
Image used for illustrative purposes only.

Tread carefully while taming inflation with high interest rates

Even though oil prices have been declining for four consecutive months, central banks are in no mood to let go.

October’s headline inflation print of 4.9 per cent—the second decline in two months—suggests that this round of our fight against inflation might be nearly over. But the country’s designated inflation fighter, the Reserve Bank of India, believes this is not the endgame and warned of further food and energy price shocks. Led by an almost 2 percentage point fall in core inflation that touched a 43-month low in October, the headline inflation rate fell to 5 per cent and 4.9 per cent in September and October, respectively, down from 6.7 per cent in 2022-23 and 7.1 per cent in July-August 2023. But the RBI sees this as a fleeting reprieve, fearing the one element that has pushed prices higher this fiscal—food inflation. Sadly, elevated food prices continue to be a risk to inflation expectations and as some high-frequency data indicates, cereal and pulse prices are climbing, threatening the central bank’s 4 per cent inflation mandate.

The last year, too, saw a similar price reprieve around this time, when headline inflation fell into RBI’s tolerance band of 2-6 per cent for the first time in a while in November 2022. The joy was short-lived as the headline inflation soared later, forcing the central bank to channel the story of Arjuna’s eye on price rise. No wonder the RBI is now unwilling to drop its guard, given that several items within the food basket including onions, tomatoes, cereal, pulses and sugar are firming up once again. Inflation is falling globally too, but not at the speed governments desire and the headline numbers may remain uncomfortably above targets in many countries for the third year in a row. Helpfully, economies are seeing some relief from crude oil prices that recently touched $74 a barrel (Brent futures), offering hope for a sustained decline in fuel inflation.

Even though oil prices have been declining for four consecutive months, central banks are in no mood to let go. They are instead arguing for a higher-for-longer interest rate regime to crush the threat for now. But there is another narrative taking centre stage: how inflation may go up again if central banks do not begin cutting rates now. It points to evidence that rate rises are often followed by higher inflation—precisely the opposite of what monetary policymakers have been trying to tackle. While the RBI is rightly emphasising the need for continued vigilance, it must be cognisant that it is the dose that makes the poison.

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The New Indian Express
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