It is becoming clear that controlling inflation will take more time.

The Result: Central banks may keep raising interest rates.

India's inflation rate sped past the Reserve Bank of India's tolerance band of 2-6% in January, triggering concerns that the Monetary Policy Committee will again raise the repo rate when it convenes next in April.

January CPI rose to 6.5% from 5.7% in December, much higher than the market expectation of 6.0%.

This data throws up three crucial points:

First, the reasons for the higher-than-expected inflation and how it turns the clock back for the RBI.

Second, the bugbear of core inflation.

And third, what this data may mean for the MPC in April.

Cereal Killer

Inflation fell below the top end of the RBI's target band in November, allowing the central bank to checkmark the first of its three-step strategy. The RBI game plan was:

Bring inflation within the 2-6% range

Break the stickiness of core inflation

Align headline inflation to the actual target of 4%

Having brought the inflation rate below 6%, the RBI had turned its eye to core inflation.

January inflation breached the tolerance band again, turning the clock back for the central bank.

It now has to uncheck its first tick.

The January inflation was set to rise to 6% due to the base effect, but an unexpected rise in cereal prices drove inflation to 6.5%. The index for cereals, which includes everyday grains like rice and wheat, rose sequentially by 2.6%, the highest margin in a decade.

Economists are puzzled by this rise and are waiting to see if this trend holds in February. Many concede that this part of inflation tends to be sticky. The first casualty of the January inflation print is the RBI's projection for this quarter. It had lowered the January-March inflation projection to 5.7% from 5.9%.

Likely overshooting projections apart from inflation printing above the target band is a setback for the RBI's war on inflation.

Sticky Core

Core inflation, which is inflation stripped off volatile elements like food and energy items, has been sticky around 6% for many months. The RBI calls it underlying inflation, which makes inflation resurgent if not controlled.

Core inflation rose to 6.2% in January, from 6.1% in December.

The reason for high core inflation is that corporate's passed on high input costs as a result of the COVID lockdowns and the Russia–Ukraine war.

High consumer demand is the prerequisite for the pass-through of high input costs. The RBI has been trying to suppress demand through interest rate increases since May 2022.

The RBI has been saying inflation has been sticky, but will be lower in the next one year from what it has been so far this year.

But the January number is perhaps going against the RBI's script. It will now have to be more resolute than what it bargained for initially.

MPC Options

Although the MPC issued a hawkish statement earlier this month, where it raised the repo rate by 25 basis points to 6.50% and deferred diluting its stance to neutral, the market saw a low probability of a rate hike in April.

Economists expected the MPC to resort to a 'hawkish pause' – where the committee would not raise rates but signal it might do so in the future.

The MPC was expected to take a breather for two reasons:

To assess the impact of the 250-basis-point increase in the repo rate effected since May, as rate transmission works with a lag.

To review liquidity as it enters a neutral territory with the expiry of some pandemic-era accommodation between April and May.

But the surprise inflation print in January queers the pitch. Still, it is not a straightforward call of a 25-bps hike in the repo rate in April either.

By the time of the April review, the February inflation data will be available.

The US Federal Reserve would have announced its policy by then. The Fed's March policy would also list out the so-called dot plot, where its officials give their projections for the Fed rate.

If Fed officials project a path for 'higher for longer' or a higher peak Fed Rate, the MPC will have to take that into account as the Fed's stance impacts the rupee's exchange rate as well as capital inflows into India.

As such, the MPC's inflation projection of 5.0-5.2% for the first half of 2024 and 5.4-5.6% for the second half are conservative - well above the market's expectations.

This means the RBI has already considered inflation surprises, if any.

Moreover, the sticky nature of core inflation may not mean that the central bank will keep raising interest rates each time the Committee meets. Core inflation appears intractable as household expenses on services such as education and housing have gone up since the pandemic.

And the MPC may have to live with that and opt for a hawkish pause in April. The RBI might tighten its purse strings to let tighter liquidity pressure bank lending rates up to suppress demand and core inflation.

This post-COVID episode of inflation has been a humbling experience even for central bankers, not just for commentators.

January inflation print only proves that the war on inflation will rage for a while.