Softer December Consumer Price Inflation (CPI) and Wholesale Price Inflation (WPI) prints of 2.2% and 3.8%, respectively reaffirm our belief that the Monetary Policy Committee (MPC) will adopt a more dovish tone in the February meeting and change its stance to ‘neutral’ from ‘calibrated tightening’.
Concerns, however, emanate from a sharper-than expected core CPI print of 5.6%. Given the benign headline inflation trajectory amid slowing growth, we expect 50 basis points (bps) of rate cuts in 1HCY19 but fiscal concerns, volatile crude oil prices and sticky core inflation may warrant a change in stance before monetary easing.
CPI moderates further to 18-month low
December CPI inflation moderated further to 2.2% (Kotak: 2.3%, Consensus 2.2%) from 2.3% in November, primarily due to sharp contraction of 2.5% in food inflation led by vegetables, pulses and sugar. On a sequential basis, CPI inflation fell by 0.4% month-on-month (m-o-m) led by 1.2% contraction in food inflation.
Sequentially, while vegetables posted a strong decline of 7.6% m-o-m, eggs, meat and fish, and pulses posted modest gains for the second consecutive month and are likely to do so in January according to the high-frequency data. Fuel and light inflation moderated sharply to 4.5% (7.2% in November) driven by sharp correction in fuel prices. We expect CPI inflation to average 3.6% in FY2019.
Core inflation softens marginally but remains elevated
December core inflation remained firm at 5.6% (5.7% in November), significantly higher than our expectations. Prices of health services, household goods and service, and education, which have remained sticky and elevated, recorded sharp increases of 9%, 6.4% and 8.4%, respectively.
On a sequential basis, core inflation gained momentum expanding by 0.2% m-o-m (0.1% in November). A recent puzzling trend has been an unprecedented average sequential increase of 1.6% in 3QFY19 in health services (especially medicines and hospital charges). On the other hand, sharp moderation in crude oil prices led to softening in the transport and communication segment to 4.3% (6.1% in November).
WPI inflation moderates to an 8-month low
WPI inflation softened sharply to 3.8% in December from 4.6% in November on the back of moderation in fuel and power inflation to 8.4% (16.3% in November) and in core manufacturing inflation to 4.4% (5% in November). On a sequential basis, WPI contracted by 1.4% after going up marginally by 0.1% in November. The pace of contraction in food inflation slowed considerably to 0.1% (3.3% in November). Within manufacturing, chemicals and chemical products contracted by 0.7% mom and basic metals by 1.2% mom, amid softer commodity prices and a strong INR.
RBI likely to change stance in February
The softer CPI and WPI prints are likely to give confidence to the MPC to change its stance to ‘neutral’ from ‘calibrated tightening’ in February. This is the fifth consecutive month that the CPI reading has been below the RBI’s target of 4%. We expect CPI at around 3.3% in March 2019.
Concerns, however, remain about the stickiness of core inflation, especially at a time when growth is expected is slow to 6.6% in 2HFY19. While volatile crude oil prices and concerns on fiscal slippage may warrant some caution, the seemingly structurally benign food inflation along with softening growth should help in capping the upside pressures. We continue to expect 50 bps of rate cut in 1HCY19.
Edited extracts from Kotak Economic Research report