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Reverting within the tolerance band

* Jul’21 headline CPI inflation eased to 5.59% but with higher sequential momentum in core. Within food, perishables showed mixed trends amid seasonality, while non-perishables were mostly lower MoM. Energy inflation was largely flat amid stable international prices. Core inflation eased to 5.9% but gained sequentially across most sub-categories, led by personal care and education. Separately, IIP growth moderated to 13.6% in Jun’21, but sequentially, activity improved across sectors with a further easing in lockdowns. Current IIP levels trail Jun’19 levels, but highfrequency indicators suggest improving growth momentum ahead, driven by manufacturing.

* We estimate FY22 inflation at 5.35% (RBI: 5.7%). Even assuming food inflation averaging around reasonable levels, core inflation will average around 6%, outdoing headline inflation. We remain watchful of the pass-through of impending cost-push pressures in core goods inflation, while the reopening-led ensuing demand revival in select contact-sensitive household services could pressure core services inflation ahead. However, the MPC may still choose to look through the spike in inflation for the near term, with the monetary reaction function currently hinging more on growth revival becoming sustainable .

CPI inflation eases and reverts to the RBI’s tolerance band

After two consecutive 6%+ prints, CPI inflation eased to 5.59% in Jul’21 (Emkay and Consensus: 5.72%) – reverting to the RBI MPC tolerance band. The sequential momentum has further ebbed for food overall, while perishables have shown mixed sequential trends amid seasonality. While vegetables (5.7%m/m), meat & fish (2.4%), milk (0.8%) led the pack, eggs (0.8%) and fruits (-0.5%) were much lower. Nonperishable items like cooking oil (-0.9%), cereals (-0.3%) and pulses (-1.2%) moderated for the second month in Jul’21 from their meaningful sequential jump in May’21. The government’s tax tweaks on edible oils and the imposition of stocking limits on pulses etc. have continued to reflect positively in Jul’21. While food inflation may remain manageable, the monsoon trajectory ahead and crop output will be crucial for the food inflation outlook. We note that sowing activity has improved despite sub-par monsoons. Energy inflation was largely flat at 12.4% yoy (up 0.6% MoM) amid stable international prices, while the transport and communication (T&C) segment showed its trickle-down effect further (1.7% MoM). Inflation pressure may remain stable in the near term, with the upcoming prints likely to be around 5.6%.

Core inflation eases sharply but momentum picks up

Core inflation (ex food, fuel and intoxicants) also eased to 5.86% (6.2% prior), albeit accompanied by higher sequential increases compared to Jun’21. Core inflation rose 0.7% MoM (0.04% in Jun’21), with only the recreation component (-0.1%) contracting. Personal care and effects (0.8%) and education (0.9%) led the core sequential momentum. We expect core inflation to remain sticky and ease modestly toward the end of the year but outdo headline inflation in FY22 significantly

IIP rises 13.6% in Jun’21, led by healthy sequential gains

The 13.6% surge in Jun’21 IIP (Emkay:15%, Consensus: 14%) was partly propelled by a favorable, albeit fading, base, which distorted the annualized figure (-2.6% 2-year CAGR). However, sequentially, activity improved across most sectors amid the easing of lockdowns further in Jun’21 across sectors, but the current levels are still trailing Jun’19 levels. Sector-wise, manufacturing rose 13% yoy, led by motor vehicles, textile products, electronics and electrical equipment. Mining and Electricity output rose 23.1% yoy and 8.3% yoy, respectively. Among use-based items, capital goods and infra and construction were up 26% and 19.1%, respectively, while consumer non-durables contracted 4.5%. High-frequency indicators suggest improving growth momentum ahead, led by manufacturing, with apparent signs of recovery visible in auto production, core sector output and electricity generation.

FY22 CPI to average 5.35%; accommodation abound even with inflation risks ahead

Today’s CPI inflation, even after easing to sub-6% levels, will likely face headwinds from the pass-through of impending input price pressures, especially core goods inflation may remain under pressure amid high global commodities and margin pressures. Meanwhile, the ensuing demand revival in contact-sensitive household services amid reopening could pressure core services inflation ahead. Overall, core inflation will likely remain sticky ahead and will likely outdo headline inflation through the year. We now see headline CPI averaging 5.35%, almost 35bps lower than the RBI’s forecast of 5.7%. With the monetary reaction function currently hinging more on growth revival becoming sustainable, the RBI is unlikely to change key policy rates this year.

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