Explain the role of 'second-round effects' and 'inflation expectations' in the RBI's decision to tighten policy despite robust growth.

In October 2026, the RBI's Monetary Policy Committee (MPC) raised the repo rate from 5.25% to 5.5% [1][2]. It did so even though it called growth "strong" and "broad-based" [1]. The hike was not aimed at the energy and food shock itself. It was aimed at the risk of that shock spreading through prices and expectations.

Energy/food shock → Headline CPI ↑ → Expectations ↑ → Wage & price demands → Core CPI ↑
                                     └──────── repo hike targets these links ────────┘

Flowchart: where monetary policy acts on a supply shock

Second-round effects: stopping the shock from spreading

• First round vs second round: a rate hike cannot produce more oil or food. Second-round effects happen when workers demand higher wages and firms pass higher costs on to other goods. Monetary policy can act on this stage.
• Early signs: headline CPI is expected to average about 5.8% over the next three quarters, while core inflation is projected at 4.4% [1]. The core projection was 4.3% in August [2]. The rise is small, but it is moving the wrong way.
• Structural risk: the RBI's discussion paper on its inflation-targeting framework notes the high weight of food in the CPI basket. This makes it easier for food shocks to pass into wider inflation [3].

Inflation expectations: what turns a shock into lasting inflation

• Households judge inflation mainly by visible food and fuel prices. Higher expected inflation leads to wage bargaining and earlier buying, which makes the expectation come true.
• The RBI said it is tracking inflation expectations and firms' pricing behaviour to see whether price pressures are spreading [1].
• Credibility: the RBI Act sets a 4% CPI target with a ±2% band [3]. A 5.8% average leaves little room below the upper limit, so acting early protects the anchor.

Why tighten despite robust growth

• Little cost to output: strong momentum gives the RBI room to tighten without a sharp slowdown [1].
• Turning point: CPI inflation had been below target for 16 straight months before it rose to 4.4% in June 2026. The August projections put Q3 inflation at 5.9% [2].
• Global pressure: rising energy and food costs, higher bond yields in advanced economies and a strong dollar [1].
• Measured step: the Governor linked the "duration and extent" of the hiking cycle to incoming data [1].

Overall, the RBI's hike is a pre-emptive move against inflation spreading rather than a response to inflation already out of control. A small, data-dependent tightening backed by clear communication can keep expectations anchored. This protects the flexible inflation-targeting mandate and keeps the purchasing power of poorer households, who spend most on food, central to price stability.