RBI likely to hike rates on March 17 as February inflation remains stubbornly high : JPMorgan

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India: RBI likely to hike rates on March 17 as February inflation remains stubbornly high

Inflation shows no signs of abating with February inflation printing at 8.3 % oya, belying market expectations of a moderation to 7.8 % oya While primary food inflation expectedly moderates, the monthly momentum of non-food manufacturing inflation increases sharply and is now running well into double-digits Meanwhile, December inflation is revised up by a whopping 100 bps to 9.4 %; sharp retrospective revisions over the last 3 months suggest that February inflation will likely end up closer to 9% in the final analysis With the current inflation trajectory significantly above the RBI’s comfort zone and showing no signs of abating, the RBI is expected to hike policy rates by 25 bps at its mid-quarter review on March 17 February inflation remains stubbornly high, exceeds market expectations February WPI inflation printed at 8.3 % oya accelerating further over January’s inflation print of 8.2 % oya and belying market expectations of a moderation (Consensus: 7.8 %). In response, the 1Y OIS rose 7-8 bps while the benchmark 11-year government security rose 5 bps. It was widely anticipated that primary food inflation would moderate in February after surging more than 9% sequentially over the last three months. Expectedly, primary food inflation moderated to 10.6 % oya (- 3.9 % m/m, sa) from 15.6 % in January, driven primarily by a reduction in fruits and vegetables inflation. Recall, these prices had surged due to idiosyncratic supply shocks over the last few months, and prices have mean-reverted once these shocks were reversed. It is important to note, however, that despite the moderation, inflation rates for fruits and vegetables, milk, eggs, meat and fish continue to remain in the double-digits. While primary food inflation is likely to abate further, it is likely to remain range-bound at the 7-8 % levels where it has been over the last four years for the structural reasons that we have outlined earlier (see, “September inflation remains sticky; primary articles are the primary culprit,” October 15, 2010). Meanwhile, elevated global commodity prices continued to drive non-food primary article inflation further up (4.9 % m/m, sa) and inflation for this sub-group is now running just a shade below 30 % on a year-on-year basis. Prices of the usual suspects – raw cotton, rubber, oil seeds – continued their upward march Momentum of non-food manufacturing inflation continues to surge This much was expected. What the market had not anticipated was a sharp surge in the prices of non-food manufactured prices in February, which rose 1.6 % m/m, sa – the highest month-on-month increase since 2004 We have been arguing for a while that the sequential momentum of non-food manufacturing inflation is already running close to double digits and that a sustained increase in manufacturing input prices in conjunction with increasing capacity constraints across various sectors suggests that manufacturing prices are poised to accelerate even further. With leading indicators like PMI output prices suggesting a pick-up in output prices in response to surging input prices and anecdotal evidence that prices of various manufactured goods (e.g. steel, cement, textiles) have increased, it was expected that manufacturing inflation would indeed accelerate, though the magnitude surprised on the upside. This is also likely payback for the fact that some of the price increases that were expected to be captured in the January index (which showed a muted sequential increase in manufacturing inflation) were instead reflected in February. With input prices continuing to surge in February, prospects for non-food manufacturing look sobering. We have been arguing for a while that headline inflation is expected to stay sticky in the 8-9 % range for much of 2011, primarily on account of sticky manufacturing inflation. December inflation revised up 100 bps to 9.4 % Despite the move to a new WPI index, the one constant over the last year has been sharp retrospective upward revisions to inflation. This month was no different with December inflation revised upwards by 100 bps from 8.4 % to 9.4 %. The increase was evenly distributed with all sub-components of primary inflation and manufacturing inflation moving up. It is important to note that post the revisions the momentum of non-food manufacturing inflation increased to 1.1 % m/m, sa in December from 0.8 % in November. This monthly momentum has increased to 1.6 % in February, and these numbers are yet to be revised! With every month over the last 3 months witnessing a 60-100 bps retrospective revision, it is likely that February’s print will end up closer to 9% in the final analysis – a far-cry from the 7% that the RBI has forecast for end of March 2011. RBI expected to raise rates by 25 bps on March 17 With headline inflation, and non-food manufacturing inflation in particular, continuing to accelerate and the continued threat of high oil prices still very real, it is expected that the RBI will continue its monetary tightening process, albeit in its preferred calibrated approach, and raise policy rates by 25 bps at its next mid-quarter review on March 17. In past reviews, the RBI had justified their actions by pointing out that inflation was expected to moderate to 7% by end-March 2011, that non-food manufacturing inflationary pressures were still relatively muted, and that it was important that fiscal consolidation help do some of the heavy lifting to contain inflationary pressures. Each of these justifications now ceases to exist. With February inflation printing at 8.3 % (and likely to be revised up even more in time to come), it is clear that March inflation will print significantly higher than the RBI’s forecast of 7 %. In addition, it is now clear that inflation is broad-based and that non-food manufacturing is running well into double-digits on a sequential basis. Finally, with the FY12 budget targeting a lower-than-expected fiscal deficit and thereby indulging in an effective fiscal consolidation of more than 1.5 % of GDP (see, "FY12 budget surprises positively but beware of the fine print," February 28), it is clear that fiscal policy will be endeavoring to keep up its end of the bargain. It is important, therefore, that monetary policy continue to be tightened, and we expect policy rates to be hiked another 25 bps on March 17.