Yet another soft inflation print. WPI inflation softened as a sharp fall in vegetable prices offset the adverse base effect and higher core inflation. We expect both CPI and WPI inflation to have bottomed out, with CPI inching towards 4.4% and WPI towards 3%, by March 2018. With inflation trending up directionally and growth seeming to stabilize, we see limited room for rate cuts. But we will be watchful of any incoming data surprises to review a shift in RBI's reaction function, if any.
WPI inflation moderates on soft food prices
September WPI inflation moderated to 2.6% compared to 3.24% in August (Exhibit 1). The softness in WPI inflation was primarily led by slower momentum in food inflation. Primary food inflation registered a reading of 2% compared to 5.8% in August. The sequential momentum showed a sharp contraction in food prices ((-)4% mom compared to an average increase of 2% mom between April-August 2017), led by vegetable prices ((-)23.7% mom) and fruit prices ( (-)0.8% mom). However, the price of pulses and food grains surged by 5.7% mom and 1.1% mom respectively. Further, the prices of manufactured food increased 0.7% mom, thereby registering a 1.99% yoy growth for the weighted WPI food inflation. In addition, the increased GST rate continues to put pressure on beverages and tobacco (0.8% and 2.2% mom respectively). Energy inflation, expectedly, registered 9% yoy led by 1.7% mom (0.9% mom in August) increase in the index reflecting trends in global oil prices and domestic prices of fuel products.
Core inflation surges to a three year high
Core inflation in September increased to 2.8% compared to 2.5% in August, led by the adverse base effect and sequential increase in prices due to higher global commodity prices and in part adjustment to GST rates. The heaviest weight item in core inflation, 'basic metals' surged 2.7% mom, 'chemicals and products' increased 0.1%, textiles by 0.6% and 'pharmaceuticals, medicinal chemical and botanical products' increased 0.5% mom. On the other hand, 'motor vehicles, trailers and semi-trailers' and 'machinery and equipment' witnessed a decline ((-)1.3% mom and (-)0.2% respectively).
Limited room for monetary easing but incoming data surprises remain key
Despite softer retail and wholesale inflation prints this month, inflation trajectory is trending higher amid the adverse base effect and higher global commodity prices. We expect CPI inflation (exc. State's implementation of 7CPC) to trend towards 4.4% by March 2018 and 4.9% by March 2019. Further core CPI inflation is expected to remain persistently around 4-5% through FY2019. We see WPI headline inflation undershooting retail inflation and restating weak pricing power. With RBI fixated on the 4% target on a durable basis, and with a plausible case of fiscal slippage, room for further policy easing in the near term looks limited, unless data surprises on the downside significantly. In this context, we will continue to monitor the evolution of (1) crop production, (2) downward surprise of core inflation owing to weaker-than-expected growth, (3) second-round impact of lower excise duty on petrol and diesel, and (4) status of the government's accounts.