The latest discussions around inflation highlight a few interesting sub-topics which have a bearing on when the central banks in India and abroad, particularly in the US, would cut interest rates.

The themes around inflation are the following:

The tail of inflation (the last leg of the disinflation process affected by higher interest rates) will take a lot of time to get straight or come in control. There is a far greater transmission of inflation in one item to other items. Inflation is primarily in food items, whereas inflation in industrial items is falling. In other words, WPI is falling, whereas CPI—where food has a higher weight--is rising again.

All indications from these sub-topics on inflation are that central banks will not be in a position to cut interest rates in a hurry.

The latest data shows that CPI inflation for June rose to 4.8% from 4.3% in May mainly due to a rise in food inflation.

The positive momentum in inflation was 110 basis points, which was offset by a high base effect, resulting in a rise in headline inflation by 50 basis points.

Wholesale price index inflation fell to an 8-year low of (-) 4.1%. This measure of inflation fell sharply due to a fall in minerals, fuel, power, manufactured products, and a high base last year and has been in a deflationary zone for three months.

As we know, WPI measures the average change in prices of goods traded in the country, while CPI measures the average change in prices of a basket of items consumed by households. The weights in WPI are based on production, while CPI is based on the average household expenditure.

The problem is that the favorable base effect is wearing out and the rising prices of vegetables, rice, and pulses will start to hurt.

Among vegetables, prices of tomatoes have jumped. According to some estimates, by 700% in the current financial year. Some other items like cauliflower, chilly, ginger, coriander, carrot, cabbage, brinjal, and capsicum rose 30-700%.

It is likely that WPI inflation too will reverse the trend and start to rise. Typically the CPI tails the WPI and not the other way around.

That was the second topic of discussion around inflation – the demonstration effect. A recent Reserve Bank of India paper notes that price spillovers across consumption categories are slightly larger in the current inflation episode than in the past.

This implies that increases in the price level due to price shocks in one category are propagating to others and sustaining overall inflation pressures. High prices of cereals, and consequently fodder, could also drive up inflation in protein items. Prices of milk are already high due to Lumpy Skin disease.

An interesting aside is the falling manufactured food items inflation. Inflation in manufactured food products has fallen faster than the headline inflation. Inflation in manufactured food products has declined from 4.0% in January to (-)6.0% in June, primarily on account of a sharp decline in prices of vegetable oils. The vegetable oil index in WPI has declined 28.2% so far in 2023-24.

Notwithstanding what the headline numbers may indicate, the RBI will remain worried about the new trends in inflation. The so-called last mile effect on inflation, or the convergence of inflation to targets will be delayed. This is largely due to the prevailing high wage effect in most of the advanced countries and also due to industries’ preference to protect margins by not passing on the benefits, if any, of the recent fall in prices of intermediate goods.

This is typical behavior with firms looking to recoup losses suffered in the past (in this case the COVID-19 years). The trend noted is that price levels are rising irrespective of consumption pattern and the price changes across categories are looking identical.

The biggest worry for the central banks is that the price pressures are becoming generalised. To that extent, the central banks, including the RBI, are careful not to let the markets run away with the belief that interest rate cuts are around the corner.