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* September CPI inflation further rose to 7.4% led by food, with unseasonal rain disrupting supply, while core inflation stayed sticky at 6.26%. Sequentially, higher prices of staples such as cereals & pulses and of perishables like vegetables & milk along with spices drove up food inflation. Core inflation stickiness showed lower imported-goods' prices were largely offset by rise in prices of other segments.

* Prices of global commodities (ex-energy) on an average are easing which, if sustained, should release some cost pressure. But one would need to watch for any near-term offsetting factors, which may come from perishable food owing to unseasonal rains, second round lagged impact of higher energy prices, INR weakness, etc. With short-term domestic demand being fairly resilient, core CPI pressure may remain reasonably sticky sequentially, in the near term. That said, lower imported inflation & base effects should directionally still imply lower inflation on YoY basis in H2FY23 vs H1FY23.

* We are currently tracking October inflation at ~6.3%, with inflation in H2FY23 at 6% and the FY23-avg at 6.6%. This is, however, unlikely to derail the RBI’s front-loaded tightening path: the RBI is still some distance away from its supposed real neutral rate of 0.8-1%, even as the forward real repo rate has already become a tad positive. We still believe the RBI may not turn too restrictive and stay around the estimated neutral real rates, implying hikes of ~50bps ahead. But we reckon the situation is fluid and the extent of global disruption will remain key to the RBI’s reaction function ahead.

CPI inflation meets expectations at 7.4%; food inflation stays elevated

CPI inflation came in at 7.41% in September, nearly meeting expectations (Emkay: 7.37%; Consensus: 7.36%), with higher food inflation once again keeping the headline print elevated. With inflation staying above 6% for three consecutive quarters during the inflation targeting regime, the MPC will be obliged to submit an explanation to the government. However, it is not clear if the formal MPC response will be made public. That said, lower imported inflation on net & base effects should directionally still imply lower inflation on YoY basis in H2FY23. As regards the print, elevated food inflation (8.6% YoY; 0.91% MoM) reflects the irregular monsoon distribution and unseasonal rain disrupting supply. Sequentially, higher prices of staples such as cereals (2.0%) & pulses (1.1%), and of perishable items such as vegetables (2.6%), milk (1%) & spices (1.6%) drove up food inflation, while oils & fats (-1.92%) and fruit (-4.2%) saw a fall. High-frequency mandi prices show perishable vegetable prices inching up, possibly reflecting unseasonal rains/floods in some states and the consequent crop damage. However, meat prices should ease due to the upcoming festive season. Energy inflation saw mild relief, albeit remaining elevated, with a minor sequential uptick (10.4% YoY; 0.4% MoM). However, second-order effects of higher fuel prices in H1 of the year continue to be felt in the Transport & Communication (T&C) category as well as other sub-components.

Core inflation marginally rises to 6.3% and stickiness risks prevail

Core inflation (ex-food, fuel and intoxicants) marginally increased to 6.26% YoY (0.3% MoM), largely due to higher prices of clothing & footwear as well as of household goods and services. Personal care & effects eased sequentially, partly reflecting falling gold prices, while cost of health products, household goods & services and recreation & amusement saw a moderate increase on a sequential basis. The upcoming festive season could be a tailwind for output prices, amid demand resilience. The modest T&C increase echoed the lower momentum in rising prices of petroleum products; however, public transport fares would see a rise in some cities in coming months. Housing inflation may also warrant a watch, as rental inflation tends to rise with higher cost of home-loan financing.

August IIP contracts across the board, on slower activity and base effect

August IIP growth surprised on the downside, contracting 0.8% YoY (Emkay: 1.3%; Consensus: 2.4%; prior: 2.4%), with broad-based slowdown due to consolidation in activity and an unfavorable base. Manufacturing output fell by 0.7% YoY (-2.9% MoM), weighed down by segments such as pharma, apparel and electrical equipment. Electricity grew 1.4%, while mining declined 3.9%. In use-based sectors, consumer durable & consumer non-durable goods reduced YoY by 2.5% & 9.9%, respectively, while other sub-segments also slowed down. Infrastructure Goods was the only sub-sector to see sequential momentum (+0.6% MoM). The overall IIP index remains below pre-Covid levels, reflecting plateauing economic momentum amid slower manufacturing exports and higher cost of capital.

FY23 CPI to average near 6.6%; the rest of FY23 to see a +50bps hike

Even though India’s inflation has peaked, it still warrants caution. Despite mild easing in the input cost of production, the inflation outlook is fraught with considerable uncertainty, given the volatile geopolitical situation, global financial market volatility, supply disruptions and unseasonal rains, while resilience in demand could also keep core inflation high. We are tracking October inflation above 6.3% and expect H2FY23 inflation to ease to 6%. The current forward real repo rate, while positive, is still lower than RBI’s estimated real neutral rate of 0.8-1%. We still think that the RBI would not turn too restrictive and the terminal rate could hover near the estimated neutral real rates, implying ~50bps hikes ahead. However, the extent of global disruption will remain key to the RBI’s reaction function ahead.

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