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Near-term peak

* Unfavorable base effect pushed Jan’22 headline CPI inflation a tad above RBI’s tolerance limit-- rising 6.01% (5.66% in Dec’21). However price momentum fell, led by food (vegetables, fruits, edible oil, and pulses). Mandi prices suggest that vegetable prices continue to fall. Core inflation eased mildly to 6.20% as the impact of the telecom tariff hike was offset by the tax cut-led decline in motor fuels, while other core components, barring housing, saw stable sequential momentum.

* We currently see Feb’22 inflation easing to 5.75%, led by a sharp moderation in core inflation. While there may be some overdue increases in motor vehicles fuel costs Mar’22 onward, the broad mild downtrend in headline inflation ahead is unlikely to get disturbed meaningfully.

* Overall, we see both headline and core inflation peaking here and moderating ahead, led by contained price momentum. However, our forecast is ~70bps+ higher than that of the RBI (Emkay: 5.25%; RBI: 4.5%) with risk largely balanced. We remain watchful of inflation push-and-pull factors such as 1) oil shocks, 2) volatility in vegetable prices, 3) early signs of easing supply chains globally, 4) contained household inflation expectations, and 5) the impending demand revival.

* Nonetheless, for now, the RBI is in no rush to change its policy stance, and its reaction function remains hinged to growth. We will see shallow normalization ahead, with policy rate hikes not commencing at least before 2HFY23, with RBI in an active wait-and-watch mode.

Unfavorable base effect propels CPI inflation in Jan’22

CPI inflation expectedly surged 6.01% in Jan’22 (Emkay 5.95%, Consensus 6%) from 5.66% (revised) in Dec’21, owing to low base effects of last year. This was reckoned by RBI governor in his speech today. He indicated that the surge in inflation may be due to statistical reasons (unfavorable base), which is not a reason to panic. The sequential moderation was seen in prices of food, except cereals and fuel, while housing and miscellaneous categories picked up pace. Within food, major easing was seen in vegetables (-7.4% MoM), oils and fats (-1.6%) and fruits (-0.8%). Mandi prices indicated a sharp fall in prices of vegetables in Jan’22 and even in Feb’22 so far. The impact of duty reduction on palm/edible oil was evident in Jan’22; it may continue to ease further. Energy inflation eased further for the third consecutive month, with flat sequential gains.

Core inflation eases, but momentum picks up

Core inflation (ex food, fuel and intoxicants) moderated to 6.2% (6.31% prior). Jan’22 witnessed housing rentals picking up pace, in line with seasonal trends (0.7% MoM vs. 0.5% MoM in Dec’21). T&C reported a healthy sequential gain of 0.58%, led by the spillover of telecom tariff prices. Within the miscellaneous category, momentum improved for education (0.18%) and health (0.47%), while it slowed for recreation activities (0.37%). We expect core inflation momentum to ease ahead, as the impact of telecom price hikes fades and a negative output gap limits the full pass-through of high input costs. However, the impending fuel price increase may put pressure ahead. We see core inflation peaking and heading to an average of 5% in FY23.

WPI inflation moderates but still elevated

WPI inflation moderated in Jan’22 on expected lines but still hovers at elevated levels of 12.96% (Emkay 12.96%, Consensus 12.7%). Prices of manufactured products eased (9.42% vs. 10.62% in Dec’21), providing major support to the headline, but rose sequentially by 0.5% MoM. Softening of prices of mineral oils (0.8% MoM), crude and petroleum gas (-5.1% MoM) also helped ease the WPI headline to some extent. Electricity prices picked up steam (15.9% MoM vs. -11.3% MoM in Dec’21). The sequential fall in prices of food (-1.6% MoM) continued for two months in a row.

FY23 CPI to average 5.25%; RBI likely in “wait-and-watch” mode

The inflation print today saw the base effect play a large part in pushing the headline print above the RBI’s tolerance limit. We think the peak in core and headline inflation is likely behind us. While there may be some overdue increases in motor vehicle fuel costs Mar’22 onward, the broad mild downtrend in headline inflation ahead is unlikely to get disturbed meaningfully. However, we reckon inflation is unlikely to ease to 4.5% in FY23 and will likely average around 5.2%. The risk of the pass-through of cost-push pressures into selling prices and higher crude will weigh on the RBI’s forecast, but that could be tempered due to weaker demand dynamics. Nonetheless, for now, the RBI is in no rush to change its policy stance. We will see shallow normalization ahead, with policy rate hikes not commencing at least before H2FY23 with the RBI in an active wait-and-watch mode

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