9.4% inflation + 5.6% IIP = 25bp RBI rate hike :: BofA Merrill Lynch,

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9.4% inflation + 5.6% IIP =
25bp RBI rate hike
9.4% June 2011 WPI inflation
Actual:          9.4%
Previous:      9.1%
Consensus:  9.7%
BofA ML:      9.6%
Bottom line: 25bp RBI rate hike on July 26, September    
„ We continue to expect the RBI to hike rates by 25bp on July 26 after June
inflation came in at a high 9.4%. With inflation set to touch 10% in July-August,
we are advancing our final 25bp rate hike to early September from October. It
will only be after inflation peaks off in September as we expect that the RBI will
be able to pause in October. If inflation slips to 6% levels by 1Q12, as we
expect, the RBI should be able to cut policy rates by mid-2012. In tandem, we
expect lending rates to go up 25-50bp by March 2012 and come off 50bp in the
April-September 2012 slack season. The 10y, however, should remain chained
to its current 8-8.5% trading range with our expected 1% of GDP fiscal overrun
likely to be funded by RBI OMO.  Swing factor: monsoons. Do read our latest
RBI report here.  
Why it matters: Hawkish RBI policy on July 26  
„ We expect the RBI to persist with its hawkish monetary policy stance on July
26. Given emerging monsoon risks at a time of high inflation, we doubt if
Governor Subbarao will signal a monetary policy pause as some think.
Although May industrial growth, at 5.6%, was well below our 8.6% forecast, we
do not see this deterring the hawks from screeching for further RBI action.
After all, our own stress tests suggest that higher rates, per se, are unlikely to
pull growth below 7.5% unless there is a parallel global shock or a drought.  
Key points: Weak July rainfall emerging inflation risk      
„ June inflation, at 9.44%, came in broadly in line with our expectations (Chart 1
and Table 1). Although core inflation works out to a benign 5.7%, it should be
revised up to 6-6.5% when the final data come in (Chart 2 and Table 2). On
our part, we expect core inflation to touch 8% levels in 2H11.
„ Inflation will likely climb to 10% levels in July-August as the full blast of the
June 24 hike in administered fuel prices shows up (Table 3). Delhi hiked prices
of diesel (9%), cooking gas (14%) and kerosene (16%) pushing up inflation by
73bp directly and 120bp overall. Since monthly inflation is calculated by
averaging weekly fuel price data, the direct impact showed up only partially in
the June data.  
„ Weak rains during the critical sowing month of July are emerging as an
inflation risk. The IMD just reported monsoon deficiency at a very worrisome
19% below normal during the week ended July 13 over and above 25% last
week (Chart 3). A 5% swing in agflation impacts inflation by 175bp