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Food-led moderation in January inflation

January CPI inflation moderated to 5.1%, in line with expectations, and core inflation remained subdued at 3.5%. The inflation trajectory has begun softening although the risks remain skewed toward the upside. We maintain our FY2024-25 headline inflation estimates at 5.4% and 4.5%. We continue to expect the RBI to change its stance by end-1QFY25 followed by rate cuts in 3QFY25.

Moderation in January inflation led mainly by vegetables

January CPI inflation at 5.1% (December: 5.7%; Kotak: 5.3%) was broadly in line with expectations. Sequentially, headline inflation contracted by 0.1% (December: (-)0.3%) led mainly by vegetables, followed by fruits, spices, pulses, and oils and fats (see Exhibits 1-2). Meanwhile, prices of cereals, meat and fish, and eggs increased in January (see Exhibit 3). Positively, durable inflation (though elevated) and food and beverages inflation (excluding vegetables and fruits) have been on a downtrend over the past few months (see Exhibit 4).

Core inflation remains subdued at sub-4% levels

Core CPI inflation (CPI, excluding food and beverages, and fuel) was at 3.5% (December: 3.8%). Sequentially, core CPI increased by 0.3% (December: 0% mom), led by higher medical costs, bus/tram fares, and gold. Overall, the moderation in various measures of core inflation will continue to provide comfort to the MPC (see Exhibit 5). We expect FY2024E-25E core inflation to average 4.4% in both years.

Factory activity improved in December

Despite an unfavorable base effect in December, IIP growth increased by 3.8% (November: 2.4%) led by manufacturing activity. Sequentially, IIP increased by 7.4% (November: (-)2.4% mom) as activity normalized post festive season. As per the sectoral classification, manufacturing activity increased by 3.9% (November: 1.2%), while mining and electricity production, though positive, moderated from November (see Exhibit 6). As per the use-based classification, all categories registered positive growths led by consumer durables, primary goods, and infrastructure goods (see Exhibit 7).

Maintain view of stance change by end-1QFY25; rate cuts to follow in 3QFY25

As expected, the inflation trajectory has begun softening. However, uncertainties remain from (1) adverse weather events impacting food prices, and (2) the Red Sea conflict (among other geopolitical tensions) impacting energy prices. In FY2025, baring a sub-4% average in 2QFY25, we do not see inflation settling around the 4% target (average inflation expected at 4.5% from 5.4% in FY2024E). We expect the first repo rate cut only in 3QFY25 conditional on (1) easing food price pressure, and (2) the US Fed’s rate cut cycle starting in 2HCY24. Prior to rate cuts, we expect the RBI to change its stance to neutral by end-1QFY25. On the liquidity front, we expect the RBI to continue to fine-tune system liquidity to anchor overnight rates closer to the repo rate.

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