India's retail inflation surged to 6.09% in October, breaching the Reserve Bank of India's 6% target ceiling for the first time in two years and increasing the case for further rate hikes.

A second successive rate hike seems inevitable, with most economists anticipating a 25-basis-point increase in the December policy review. 

The consumer price index-based inflation has become broad-based, with 11 of the 12 categories, including food items and services, showing hardening in prices and squeezing household budgets.

The CPI-based inflation has remained above the RBI’s 4% medium-term target for five consecutive months, with the September print being at 5.4%. This is the first time that inflation has crossed the RBI’s upper tolerance limit of 6% under the new series.

Economists expect inflation to further go up before easing. Aditi Nayar, chief economist at rating agency ICRA, expects inflation to average 6.2% in Q3 of FY27, slightly higher than the RBI’s projection of 6% for the quarter. 

“With the CPI inflation set to remain above the 6% upper bound of the RBI’s tolerance band over the next couple of months, and GDP growth likely to ease only slightly in Q2 FY2027 relative to the previous quarter while remaining above the 7% mark, a further 25 bps rate hike in December appears almost certain,” Nayar said.

Last month, the RBI raised the benchmark repo rate for the first time in nearly four years to take it to 5.50%.

The October headline inflation was driven largely by food prices, which rose to 8.94% in October from 7.74% in September. 

The top five items with high inflation were onion (116.22%), garlic (60.74%), silver jewellery (52.39%), ginger (48.32%) and lemon (47.30%).

Inflation was also led by transport-related costs, clothing, housing and food-serving services.

"We expect the next few readings to remain elevated above 6 per cent amid adverse base effect from GST, higher food prices and partial pass-through of higher commodity prices," said Upasna Bhardwaj, chief economist at Kotak Mahindra Bank.

Average CPI inflation has already risen to 4.7% this fiscal, above the RBI’s medium-term target of 4%. “We expect CPI inflation at 5.3% average this fiscal with risks tilted at the upside as food prices continue to surprise on the upside. We expect the monetary policy committee (MPC) of the RBI to retain its tightening bias and see scope for another repo rate hike of 25 basis points at its December review meeting,” said Dipti Deshpande, principal economist at Crisil.  

The RBI expects inflation to average 6% ⁠in the October-December quarter and pegs it at 5.2% in FY27.

Have external factors changed for downward revision in terminal-rate expectations?

There are four factors that have shifted the balance in favour of a rate-hike cycle not being prolonged.

Firstly, the rupee has strengthened following a slew of measures taken by the RBI, pushing it back to the 94-per dollar levels.

Secondly, the revival in foreign capital inflows amid a correction in the artificial intelligence (AI) sector in the US. FII (foreign institutional investor) inflows have already reached approximately $7.65 billion since 6 November.

Thirdly, the prospect of de-escalation in the US-Iran conflict and the improved outlook for crude oil prices. Crude oil prices have fallen to $92 a barrel from the $120 levels. 

Fourthly, the US treasury yields are likely to soften further following the Democrats’ victory in the mid-term elections. “We expect the US 10-year yield to move towards 4.75%. For India, we believe that the 10-year yields will likely settle in 6.75-7% but now with a clear downward bias,” State Bank of India’s research wing said in a note. 

The market had earlier expected a few successive rate hikes, varying between 50 bps to 75 bps, depending on the global headwinds and the price of crude oil.

“We see the terminal repo rate settling at around 6%, with a downside possibility of 5.75%. We assign a 50:50 probability to both these possibilities. We do not consider a further rate hike in February advisable, particularly given the proximity to the Union Budget,” the note said.

Oil prices are expected to stay lower and there is going to be a rebound in foreign portfolio inflows. The El Nino impact could also be limited and in certain pockets, with more impact visible in oilseeds, sugarcane and pulses.

“We expect the December 25 bps hike to be followed by a more data-dependent policy approach. This also leaves room for a downward revision in terminal-rate expectations,” the SBI note added. 

The way the rate-hike cycle moves will depend a lot on global oil prices. “The trajectory of crude oil prices, which have cooled in the recent sessions, will be critical in shaping the need for and extent of additional rate tightening in 2027,” said Nayar.