Having complied with the IMF raising the interest rates by 150 bps in May 2019 as part of prior action, the Central bank’s Monetary Policy Committee (MPC) felt more room for tightening. The policy rate is up by another 100 bps – up by 575 bps since the government took over. Not that it came as a surprise, as the market consensus was 100 bps as well, indicated by yield movement in the treasury markets and the events surrounding inflation, especially post budget.

So what changed from two months ago? The MPC expects inflation to average 11-12 percent in FY20, which it says is higher than previously projected. It is pertinent to mention that the MPC’s inflation expectations are still lower than IMF’s projections for FY20 at 13 percent average. Two months ago, the MPC had also anticipated FY20 inflation to be “considerably higher”, citing budget measures, adjustment in utility tariffs, and volatility in international oil prices.

Come July 2019, and the reasons are pretty much the same, with an addition of “upside inflationary pressures from exchange rate depreciation since the last MPC meeting”. Interestingly, the “one-off” impact of adjustments in utility prices also forms the basis of inflation expectations. This comes as a surprise as the “one-off” adjustment in electricity rates would actually go unreported as per the existing CPI methodology. Even if it were to be a part, it was not going to trouble much, given 78 percent of domestic users are exempt from the adjustment anyways.

In case of gas prices, there is nothing “one-off” about them, as that is going to result in a sizeable increase in CPI. And if the IMF country report is anything to go by, a revision in base tariff for power consumers is also just around the corner by as early as September 2019. One wonders if the MPC, when it meets next, will again these reasons enough for “considerable” increase from earlier projection.

Core inflation of late has been softening, as against headline inflation. This is suggestive of cost push inflation being on the rise, whereas the impact of tightening is increasingly visible on demand driven inflation. The policy statement gives the softening demand indicator its due share, saying the inflation expectation takes into account the downward inflation pressure from the demand side, which is increasingly visible.

What is of most significance is the policy’s forward looking tone. The statement has hinted at equilibrium levels for both interest rates and exchange rates. Not often does one find statements as forward looking as “the MPC is of the view that the adjustment related to interest rates and the exchange rate from previously accumulated imbalances has taken place”, in a monetary policy note. Could this mean the volatility in inflation expectation be limited to international oil prices, now that the exchange rate is supposedly near equilibrium, and the impact of budgetary measures has been accounted for? Have the rates peaked yet? Don’t bet just yet, the CPI for July and onwards may have a surprise or two to throw.