Economy: May WPI inflation reaffirms benign underlying dynamics - Kotak

May WPI inflation reaffirms benign underlying dynamics. Weakening food inflation dynamics contributed the most to low headline WPI inflation, largely mirroring the trends seen in CPI inflation. Core inflation picked up marginally, largely owing to sharp sequential increase in 'basic metals'. Even as WPI inflation is likely to edge up as we go ahead (largely due to fading base effect), it will remain soft to average ~3.2% in FY2018. CPI inflation also seems set to dip below RBI's inflation target band of 2-6% as early as June. Backed by softer tone in the recent policy, in conjunction with possible sub 2% June and July inflation prints, we expect a 25 bps cut in the August meeting.

WPI inflation eases sharply as food inflation seasonality pattern weakens

May WPI inflation surprised significantly on the downside (Kotak: 3.11%), printing 2.17% after 3.85% in April. The correction in inflation was seen across the board. While the favorable base effect has started to wane, sequential contraction in most major sub-components of primary, food and energy inflation helped a lower year-on-year print. Notably, food inflation mirrored the trends shown in CPI inflation, easing sharply to 0.15% after 2.90% in April, helped by sequential contraction across the board, primarily vegetables (-0.8% mom), pulses (-2.6%) and egg, meat & fish (-3.3%).

Non-food primary goods articles contracted 0.9%. Energy inflation eased to 11.7%, with sharp sequential contraction, reflecting fall in global oil prices and domestic prices of fuel products. As the favorable base effect wanes, we expect FY2018 WPI inflation to average ~3.2% as against 1.7% in FY2017.

Core inflation appears to have hit the trough

Core manufactured products inflation picked up marginally to 2.1%, largely owing to sharp sequential increase in 'basic metals'. Among the other key components, the 'chemicals and chemical products' (crude derivative) inflation was flat, while 'textiles' inflation eased to 3.3%. However, core inflation appears to have hit the trough, partly owing to base effect even as the underlying momentum remains benign. We expect core inflation to pick up sharply, particularly in 2HFY18, to average ~2.9% in FY2018 as against (-)0.2% in FY2018.

Stage set for August cut

For policy perspective, CPI continues to dominate the RBI's reaction function. However, the downturn in WPI inflation essentially depicts benign producers' input prices, which in theory should impact the retail price pressures with a lag. With consistent downward surprises in the recent months, retail inflation is set to print a sub-2% figure in June and July. This will be below the lower bound of RBI's inflation target range of 2-6%. More importantly, the MPC was keen to watch for sustenance of April's momentum and dynamics for the next couple of prints before they decide on the next rate move. It seems that the dynamics have continued well into June. Further, the May and upcoming June headline CPI inflation prints will be below the RBI's estimates, which should give room for the RBI to be accommodative. We expect the MPC to weigh towards a 25 bps rate cut in the August meeting.

Source : Equity Bulls

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