WPI inflation: overall dynamics benign.
Some upside pressure was visible in food articles, but WPI inflation surprised on the downside as core inflation dynamics remained benign. Sharp input price pressures are unlikely to manifest given benign global commodity price cycle in the near-to-medium term. This should bode well for retail prices too, especially for manufactured products. We expect WPI inflation to revert to 2.75-3% range by March 2018. We continue to pencil in 25 bps cut in the repo rate at the August 2 policy meeting.
Prices of vegetables, fruits, and protein items increase sequentially
June WPI inflation surprised on the downside with a print of 0.9% (Kotak: 1.6%). The downside came from core inflation maintaining its sequential momentum at (-)0.1%. Food inflation mirrored trends seen in CPI inflation, falling further to (-)3.5% from (-)2.3% in May, even as food prices increased mom by 0.9% with vegetables up by 10% mom, fruits by 2.7% and egg, meat & fish by 1.1%. However, cereals and pulses continued to contract sequentially by (-)0.4% and (-)2.8% respectively.
Non-food primary goods articles contracted 5.2% yoy. Energy inflation eased further to 5.3%, with sharp sequential contraction reflecting trends in global oil prices and domestic prices of fuel products. As the favorable base effect wanes, we expect FY2018 WPI inflation to average 2.2% from 1.7% in FY2017.
Core inflation nears trough
Core inflation in June fell marginally to 2% (May at 2.1%), largely due to sequential fall in ‘basic metals’ ((-)0.1%), ‘chemicals and chemical products’ ((-)0.1%), ‘machinery and equipment’ ((-)0.5%), and ‘computer, electronic and optical products’ ((-)0.5%). However, core inflation appears to have reached a trough, partly owing to the base effect even as the underlying momentum remains benign. We expect core inflation to pick up in 2HFY18 and average 2.3% in FY2018 against (-)0.2% in FY2017.
RBI likely to cut repo rate by 25 bps in August
From a policy perspective, CPI continues to dominate RBI’s thinking. But the downturn in WPI inflation essentially depicts benign producers’ input prices, which in theory, should impact retail price pressures with a lag. RBI had revised down its inflation numbers sharply in the June policy. MPC was keen to watch for sustenance of the downward momentum for the next couple of prints before deciding on next policy action. Given that inflation reading has further surprised with sub-2% print (well below RBI’s own estimates), we find some room for RBI to be accommodative. We expect the MPC to cut repo rate by 25 bps at the August meeting. But we reckon that the room for further monetary accommodation remains limited amid (1) mean reversion of food prices, (2) rising real rural wages, (3) onset of global financial tightening and (4) adverse base effect.
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