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Rising food prices push inflation over 3%; IIP growth at six month high
Headline and core inflation show divergent trends
* Food prices continue rising, push headline CPI to 3.05%: Headline inflation for May ’19 came in at 3.05% (I-Sec est: 3.07%, Consensus: 3.1%). Although this is sharply lower than 4.87% twelve months ago, in sequential terms inflation increased from 2.99% in Apr ‘19. This is the fourth consecutive month-on-month increase in inflation, taking the 3mma inflation to 2.97%.
* Sequential increase in CPI singlehandedly driven by food: As expected, rising food prices accounted for the entire sequential increase in CPI. Food and beverages inflation inched up to 2% (1.35% in Apr), contributing ~93bps to headline inflation. In line with past few months, three items viz. vegetables, pulses and sugar accounted for most of the increase in food inflation. Out of the 65bps sequential increase in food inflation in May ‘19, vegetables, pulses and sugar contributed 34bps, 15bps and 5bps respectively. However, falling prices of ‘miscellaneous’ items cushioned the impact of rising food prices to some extent.
* Core inflation eases further to 4.2%: Showing a contradictory trend to headline, core inflation eased to 4.2% from 4.5% in Apr. This is the 7th consecutive decline in core inflation. Almost all components of core basket recorded softening inflation. The largest drop came from ‘transportation and communication’ inflation followed by ‘household goods and services’ and healthcare costs. Softening core inflation is in line with the current economic slack. We expect economic growth to remain soft in H1FY20 hence core inflation is also expected to remain low for next 3-4 months
* Actual inflation likely to be higher than MPC’s forecasts: According to the MPC’s latest forecast, inflation is expected to average 3-3.1% in H1 and 3.4-3.7% in H2FY20 (FY20 full year 3.3%). However, we expect actual inflation to come in ~50bps higher than the committee’s forecast. The MPC seems to have underestimated inflation especially in H2. Our projected inflation trajectory (Chart 4) shows that CPI is likely to average ~3.3% in H1 and 4.2% in H2 taking the full year average to 3.8%. Food prices could inch up faster than the committee’s expectations, especially if monsoon precipitation is lower.
* Strong chance of August rate cut: Although full year forecast is likely to be much higher than MPC’s expectation, in Q1FY20 inflation is expected to average just 3.1%. Softening headline and core inflation along with weak growth impulses mean chances are very bright of another 25bps rate cut in August policy. However, when the committee meets in Oct ’19, inflation is likely to have inched up to ~3.8% (although there are some downside risks to the forecast). Hence, at this stage we would refrain from taking a call on rate cut beyond August.
Healthy manufacturing growth propels IIP growth to 3.4%
* IIP records best performance in six months: IIP growth came in at 6-month high of 3.4% in Apr (0.4% in Mar ’19, 4.5% in Apr ’19). From industry side, all components of IIP registered good growth. However, the biggest contributor to growth was manufacturing. Out of 3.4% growth in Apr, manufacturing contributed 220bps followed by mining (70bps) and electricity (50bps). From the use-based perspective, primary goods registered strong growth contributing 180 bps to headline growth followed by consumer non-durables (80bps). At this stage, we would avoid reading too much into IIP numbers. Growth is likely to remain weak in H1FY20 and hence meaningful and sustained recovery in IIP may not happen before the end of the calendar year.
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