A Dovish outlook on inflation, yet large risks on the upside; The MPC in its first Monetary Policy Outlook for FY 2018-19 pleasantly surprised the market by lowering the inflation forecasts for the year. Yet continued the refrain of large upside risks to inflation. The hawk in a dove: “The Dawk”.
a) Kept all the rates unchanged
b) Lowered the inflation forecasts
c) Also noted that upside risks to inflation persist and may have bearings on the inflation forecasts
d) Most significantly it also indicated a shrinking output gap and rebound in investment activity hence revising the GDP estimates for FY 2018-19 upwards to 7.40 %.
The RBI probably took away from the market an impending rate hike. Yet, it left the markets with thoughts about a possible inflation rebound. A shrinking output gap and rebound in investment activity raises the risk of inflation coming back and may let the inflation genie out of the lamp. While the first half of the fiscal year may meet the inflation trajectory, it is the second half which would be interesting. In the second half of the year, with lower inflation projected, and likely upside risks to inflation, in case of large deviations it may increase the risk of a rate action.
We think that the long end of the curve, having rallied significantly may pause and consolidate at these levels. However, the front end of the curve, specifically the credits, appears to be a better place to be invested in.
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