Inflation is in the news.

And anytime inflation is in the news, interest rates are in the news. And when interest rates are brought into the picture, the markets take notice.

That is why you absolutely must be aware of what is going on with the Reserve Bank of India, inflation, interest rates, and how how the markets can expect some extreme volatility this week.

There are two inflation numbers that get released each month: The Consumer Price Index, and the Whole Price Index. While India has historically looked at WPI inflation as being the more relevant figure to look at, RBI Governor Raghuram Rajan has insisted that we should look at CPI Inflation as the barometer on whether or not inflation is high or low.

So you might be asking: why is this important?

On Friday, CPI inflation figures for the latest month came in at an astonishing 4.38% (see below). Economists were expecting a figure of between 5.5% to 6%. Additionally, the RBI has stated that it’s CPI inflation target is 6% or lower.

India Inflation Rate

Today, at 12:00pm, the “less” important inflation figure- the WPI Inflation figure, will be released. Last month it came in at 1.77%, and this month’s figure is expected to come in at around 1.5%.

India Wholesale Price Index Change

So what does this all mean? Well, the basic dilemma is this: low inflation allows the RBI the flexibility to lower interest rates, which in turn leads to a boost in the economy. The headline Repo rate has stayed at 8%, and despite rumors of a rate cut to have occurred on Dec 2nd, the RBI stuck to its guns and kept the rate at 8%.

But now, there is a dilemma that is slowly brewing between the RBI and the government. RBI Governor Raghuram Rajan boldly stated last week that “Financial stability sometimes means (the RBI will) have to go against popular sentiment. The role of regulators is not to boost the Sensex”.

Rajan is essentially saying that the RBI looks at the Sensex rising “as a secondary objective”.

That’s all fine and dandy; but the Finance Minister, Arun Jaitley, has not been hesitant to show his displeasure with how the RBI is being resistant on cutting rates. Last week, during a debate in the Lok Sabha, Jaitley took it upon himself to voice his opinion that the RBI should cut rates to help boost the economy.

And so- it is to be seen how things will play out. The last thing the Modi government wants is any sort of public discord with the RBI. At the same time, both the RBI and central government want to portray a sense of compatibility between the two. While neither wants to succumb to the other’s wishes just for the sake of putting on a picture of the two being on the same page, the reality is that neither wants to portray that image. It would damage the image of both the RBI and the government.

The bottom line? Expect the unexpected. With Friday’s extremely low CPI inflation figure, coupled with a possible low WPI inflation figure today,  coupled with the Sensex showing signs of bearishness, coupled with troubling IIP (India Industrial Production) figures released on Friday (-4.2% versus an expected +3.83%), it seems that everybody is clamoring for a rate cut. A rate cut might very well occur this week- and if that were to happen, expect the markets to surge up.

RBI Governor Raghuram Rajan just needs to give the green light. Stay tuned.