Economy: Inflation under control for a deeper rate cut cycle by Kotak Institutional Equities
Inflation under control for a deeper rate cut cycle
CPI inflation remained comfortable at 3.3% in March with continued moderation in food prices. We expect inflation to remain around the RBI’s 4% target for most of FY2026. Based on our growth-inflation mix and the RBI’s shift in stance to accommodative, we continue to factor in another 75-100 bps of rate cuts by end-FY2026E.
Food price inflation moderates to 2.7%
March CPI inflation moderated to 3.3% (Kotak: 3.5%; Consensus: 3.6%; February: 3.6%). Headline CPI fell by 0.3% mom, led by a decline in food prices. Food inflation fell to 2.7%, led by a sharp decline in prices of vegetables, eggs, pulses and spices. Both durable and volatile food inflation remained benign at 2.5% and 3.8%, respectively. CPI excluding vegetables was stable at 4% (see Exhibits 1-4). High-frequency data for April shows a mixed picture across categories. Inflation has likely bottomed out in March but will remain around the RBI's 4% target in the near term. Urban and rural inflation have eased; however, rural inflation has eased more than urban inflation in March (see Exhibit 5).
Core inflation gradually inches higher
Core inflation (CPI excluding food, beverages and fuel) inched up to 4.1% (Kotak: 4.3%; February: 4%). Core inflation increased 0.2% mom, driven by a sharp increase in personal effects prices (mostly gold). Gold prices increased 2.7% mom in March, and the momentum is expected to continue in April. Various core inflation metrics indicate similar hardening (see Exhibit 6).
Comfortable inflation dynamics through FY2026
We expect inflation to remain benign for most of FY2026 given muted growth and expectations of favorable monsoons. Global trade disruptions, while posing downside risks to growth, may impart disinflationary pressures worldwide as export-oriented countries push excess production. IMD’s forecast of an “above normal” monsoon supports the declining inflationary path. Meanwhile, core inflation is likely to inch marginally higher on the back of base effects and a pickup in gold prices. We expect the FY2026 average headline inflation estimate to be 4% and expect the quarterly inflation to range between 3.6% and 4.4% (see Exhibits 7-8). We estimate average core inflation at 4.2% in FY2026E.
Continue to pencil in another 75-100 bps of repo rate cuts
As the inflation trajectory remains well anchored below 4% (see Exhibit 9) over the next 2-3 quarters while downside risks to growth persist, we see enough room for the RBI to prioritize growth. The RBI’s shift in stance to accommodative, along with proactive liquidity infusion, signals a willingness to continue monetary easing. We continue to expect another 75-100 bps of repo rate cut to 5-5.25% by end-FY2026E given our FY2026E growth-inflation mix (GDP: 6%, CPI inflation: 4%) and the RBI’s tolerance for two-way INR moves. We expect the RBI to keep banking system liquidity in surplus, at least over the next few months, to ensure a smooth policy transmission and avoid any credit squeeze in the event of any global trade-led disruption.
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