Economy: Inflation comfort to prompt a rate cut - Kotak

Inflation comfort to prompt a rate cut. Retail inflation continued to slide led by sustained weakness in core inflation, even as food prices begin to inch higher. A sub-2% reading further undershoots RBI's revised 1HFY18 inflation trajectory. This along with weak growth provides scope for 25 bps of rate cut in the August meeting. However, scope for further monetary accommodation remains limited as food prices and rural real wages pick up and global dynamics turn unfavorable.

Headline CPI and core inflation slip to record lows

CPI inflation slipped to a record low of 1.54% in June compared to 2.18% in May (Kotak: 1.53%, consensus: 1.67%), led largely by favorable base effect and weak core inflation. Core inflation slipped to a record low of 3.73%, down from 4.13% in May. On a sequential basis, the momentum remained muted (0.01% mom from 0.19% in May), with the weakness witnessed across the board. Excluding petrol, diesel and gold and silver, refined core index, a metrics of real underlying price pressures, also remained flat compared to 0.3% in May. Meanwhile, food inflation slipped to (-)2.1% compared to (-)1% in May. On a sequential basis, though, the food index moved up sharply by 1.3% mom primarily led by vegetables (6.1%), meat and fish (2.7%) and eggs (1.5%). Price of pulses continued to contract sequentially.

Inflation to remain benign in FY2018

We expect headline inflation to remain benign through rest of the year, with core inflation slipping lower than the headline readings in 4QFY18 reflecting weak underlying demand pressures. However, the inflation trajectory is likely to be propped up by the inclusion of 106% HRA increase of central government employees from July (estimated impact ~45 bps). Additionally, assuming if one-third of the states implement a similar increase from January 2018 onwards then overall inflation impact in FY2018 is likely to be ~60 bps. Further, we remain watchful of the recent sharp uptick in fruits and vegetables prices. However, continued disinflation in pulses and muted price pressure in cereals coupled with prompt government intervention are expected to contain sharp surge in food inflation. Nonetheless, overall CPI inflation (exc. 7CPC) in FY2018 is expected to average 3% (from 4.5% in FY2017).

IIP growth remains muted

May IIP printed a low growth of 1.7% compared to 2.8% in April. Sector-wise, manufacturing and electricity grew 1.2% and 8.7% respectively, while mining contracted 0.9%. Most of the uptick in manufacturing growth was helped by pharma products (24.5%), other manufacturing (24.4%) and other transport equipment (11.8%) while 16.5% contraction in beverages segment acted as a drag on manufacturing sector's growth. On use-based basis, capital goods contracted 3.9%, owing to unfavorable base effect. Consumer non-durables grew 7.9%, while consumer durables contracted 4.5%. Infrastructure and construction sector grew a tepid 0.1%.

RBI to cut repo rate by 25 bps in August

RBI had revised down its inflation trajectory 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 the 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 in the August meeting. However, 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.

Source : Equity Bulls

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