MPC policy, inflation and Victor Hugo

French poet Victor Hugo once said that “nothing can stop the idea whose time has come”. The quote was famously used by Dr Manmohan Singh as the concluding remark of his ground breaking 1992 budget speech when he was trying to sell the idea of decentralisation and decontrol. Apparently, the idea of jettisoning the inflation targeting regime has not come yet as was proved by the MPC decision yesterday which decided to side with caution on the inflation front.

The MPC decided to keep the repo rate unchanged with all the 6 members of the committee voting for a continuation of the accommodative stance. The key theme which comes out of the statement is that the committee is acutely aware of its primary mandate which remains keeping CPI anchored at 4% +/- 2. The inflation calculation which has been obscured by covid restrictions remains impacted on the upside by the spike in food prices owing to floods and higher pump prices of fuel. It makes any inflation outlook uncertain. The expectation though is that headline inflation will continue to remain elevated in Q2 2020-21 but may moderate going forward as the favourable base effect kicks in.

In the MPC statement, the committee acknowledged that the cumulative reduction of 250 bps since Feb 2019 is still working its way in the economy. The money, bond and credit markets are enjoying lower rates and spreads are narrowing. GDP though is expected to clock negative growth this year. The MPC announcement resulted in yields going up by close to 5 bps across the curve. However the statement by the Governor, that space for further monetary policy action is still available and needs to be used judiciously going forward to maximise its beneficial impact, provided some succour to the bond markets. The expectation now is that in case the inflation remains benign owing to a good monsoon season, a case for a cut in October policy can be built.

Globally the risk off sentiment is still the dominant theme as the tensions between the US and China spike up. The US President issued two executive orders late Thursday against two Chinese companies effectively prohibiting them from doing business in the US. The order, though not immediately executable, could result in a strong response from the Chinese side.

The negotiations between the Republicans and Democrats on the second pandemic relief package still continues without any firm agreement in sight. Mnuchin though indicated that in case they are not able to reach any conclusion by Friday, President Trump might choose to move ahead with executive orders.

On the bright side there was good news on the US jobless claims data. The initial claims which count the number of people who have been recently laid off and have filed for a claim for the first time fell by 249,000 to 1.19 million in the week ending Aug 1. That was the largest improvement in 2 months. The continuing claims remain around 16.1 million. The NFP data is due to be released today for the month of July. Expectations are that we may not see a repeat of the last month blockbuster data where the economy added 4.8 million jobs.

In the global market round up, important points to note will be gold continuing to make new highs at 2060$/oz with silver following the rise closely. On the currency side it would be interesting to look at Turkish Lira which has lost 15% in the last two trading sessions. More on that in a later note.