Inflation increases, driven by primary articles says Motilal Oswal

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n  Headline inflation increases slightly

WPI inflation stood at 8.62% Y-o-Y for September, slightly higher than consensus and Edelweiss estimates (8.5% Y-o-Y and 8.3% Y-o-Y respectively). Inflation for August stood at 8.5% Y-o-Y. While fuels and manufacturing group inflation declined from the levels seen in August, inflation for primary articles increased.

Although inflation in September was slightly higher than August, the broad trend over the last five months has been one of softening. M-o-M (3MMA) as well headline inflation, primary articles’ inflation, and manufactured groups’ inflation is generally on a moderating trend. Non food manufacturing inflation, which RBI closely monitors, is broadly on a softening trend as well (~6.0% Y-o-Y in April to 4.9% Y-o-Y in September).

n  Inflation to soften but rising commodity prices a key risk

We expect inflation to soften from the current levels. With base effect expected to be favorable, we anticipate inflation to cool off to ~6.0-6.5% by Q4FY11E. In primary articles, the base effect is expected to play out from Q3FY11, while the manufacturing and fuels group is expected to reflect the effects of a favorable base from Q4FY11. However rising commodity and crude prices (S&P GSCI up by 13% and crude up by 16% since Aug) on the back of easing monetary stance by global central banks, particularly Fed, is a key risk.

n  RBI in wait-and-watch mode

The RBI hiked repo rate by 25bps and reverse repo rate by 50 bps in its mid-quarter review in September. While the hikes were a bit aggressive than we expected, the accompanying statement was much softer compared with July policy meet. The central bank acknowledged that the monetary situation is close to normal. This suggests that policy rates have reached close to the levels that is neither restrictive nor accommodative for the economy. Accordingly, RBI is adopting a wait and watch stance in our view, where it will monitor not only the incoming economic data, particularly inflation, but also some of the global indicators.