ECOSCOPE : The Economy Observer : From food to fuel, inflation risks are broadening by Motilal Oswal Financial Services Ltd
* India’s CPI inflation rose to 4.8% YoY in Aug’26 from 4.5% in Jul’26, moving further above the RBI’s 4% target. Food inflation accelerated to 6.0% in Aug’26 from 5.5% in Jul’26. Rural inflation at 5.2% was significantly higher than urban inflation at 4.3%. The August increase was still largely driven by food prices.
* Within the food basket, price pressure remained highly uneven, with high inflation in several vegetables and food items. The food basket saw steep increases in onion (+48.3%), ginger (+73.8%) and garlic (+43.6%), although this was partly offset by continued deflation in tomato (-31.1%) and potato (-13.1%).
* Importantly, the August inflation increase was not confined to food. Transport inflation remained elevated at 4.6%, while restaurant and accommodation services inflation rose to 8.4%. Personal care and miscellaneous goods and services inflation stood at 15.2%, largely reflecting elevated precious metal prices. In contrast, education, health and housing inflation remained contained. Thus, while the core inflation backdrop is relatively benign in several demand-sensitive categories, services and selected discretionary categories continue to show pricing pressure. Core inflation (CPI excluding food and fuel) increased to 4.2% in Aug’26 from 3.9% in Jul’26.
* The CPI print, however, needs to be viewed against a materially worsening global commodity backdrop. Brent crude oil prices are once again hovering around USD110/bbl (highest in four months), while the global oil and gas market is in a particularly tricky situation amid heightened geopolitical and supply risks. This is especially relevant for India as the economy is entering a fresh oil shock, with producer prices already elevated. WPI inflation stood at 9.9% in Aug’26, with Fuel & Power inflation at 22.9%, mineral oils at 38.5% and crude petroleum & natural gas at 34.4%. Manufacturing inflation remained high at 8.4%, indicating significant upstream price pressures that could eventually feed into CPI.
* While the current CPI inflation is below the RBI’s FY27 projection and core inflation is yet to show a broad-based acceleration, the risk has shifted from the level of inflation to its trajectory. Steady Brent crude prices around USD100– 110/bbl could raise transportation, logistics, chemical and manufacturing costs and increase the risk of second-round pass-through into services and core inflation in 3QFY27. The August WPI data reinforces this concern, with output prices remaining firm even as aggregate manufacturing input prices have started to ease.
RBI may not wait for 3Q inflation to broaden
* The RBI appears to be increasingly preparing for a more difficult inflation and liquidity environment. It has already initiated sizeable liquidity absorption measures ahead of the Oct’26 policy, including the latest INR1t OMO sales announced on Friday, along with VRRR operations. In our view, the scale and timing of these operations suggest that the RBI is becoming more proactive in managing surplus liquidity and preventing financial conditions from becoming excessively accommodative.
* We now see a meaningful possibility of an RBI rate hike in Oct’26, rather than waiting for the broadening of inflationary pressures to become fully visible in 3Q data. Given the lag in monetary transmission, the RBI may prefer to act preemptively if crude remains elevated and inflation expectations begin to move higher.
Global rates add to the domestic bond-market pressure
* The external rate backdrop has also turned less supportive. The US 10Y yield has crossed 5% for the first time since 2023, while the Indian 10Y G-sec yield touched 7% on Friday. Higher US yields, elevated crude and active domestic liquidity absorption are now reinforcing each other, limiting the scope for a meaningful decline in Indian bond yields.
* We, therefore, retain our 7.0-7.2% range for the Indian 10Y yield for the remainder of FY27. More importantly, we see the potential for 75-100bp of rate hikes in the current tightening cycle if the oil shock persists and begins to expand into core inflation and inflation expectations.
Outlook
* The August CPI print by itself remains manageable, but the forward-looking inflation risk has increased materially. Food inflation is already close to 6%, WPI inflation is near 10%, brent crude has returned to around USD110/bbl, and global bond yields have surged. We expect the combination of elevated food prices and renewed energy pressures to push CPI inflation above 6% in 3QFY27, taking inflation beyond the RBI’s upper tolerance threshold. We retain our FY27 CPI inflation forecast at 5.1%, above the RBI’s 5.0% projection, reflecting greater risks from crude, food and second-round effects
* With the RBI already undertaking aggressive liquidity absorption, we believe the policy reaction function is shifting toward pre-emptive tightening. An October rate hike is now a meaningful possibility, particularly if crude remains elevated. We retain our 7.0–7.2% 10Y yield range for the rest of FY27 and expect 75-100bp of cumulative rate hikes in the current cycle under a sustained oil-shock scenario.
For More Research Reports : Click Here
For More Motilal Oswal Securities Ltd Disclaimer
http://www.motilaloswal.com/MOSLdisclaimer/disclaimer.html
SEBI Registration number is INH000000412
