India: June inflation accelerates but less than expected; 25 bps rate hike on July 26 still on --JPMorgan

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India: June inflation accelerates but less than expected; 25 bps rate hike on July 26 still on

June inflation accelerates to 9.44% from 9.06% in May, but is less than the market had anticipated Core inflation moderates sharply on a sequential basis, but only marginally on a year-on-year basis Too early to conclude whether the sequential moderation of core is on account of a slowing economy or simply constitutes a temporary respite after sustained manufacturing price increases in previous months April inflation revised up a whopping 108 bps to 9.74% With inflation expected to accelerate further in the coming months, RBI likely to continue with its anti-inflationary stance by hiking policy rates another 25 bps on July 26     June inflation accelerates further, but less than was expected   Inflation continued to accelerate in India with the June print coming in at 9.44 % oya (0.7 % m/m, sa) compared to May’s print of 9.06 %, but the acceleration was less than the market had expected (Consensus: 9.7 % oya, JP Morgan 9.8%). The lower-than-expected print was driven by a surprising moderation in the monthly momentum of core inflation, but it remains to be seen if this trend will sustain or whether June simply constituted a respite in the wake of surging manufacturing prices in the last few months (see discussion below).   While the equity market rallied 0.6 % on expectations of less aggressive monetary tightening, the 1YOIS gyrated through the day – declining by 10 bps before the print was released on rumours of a lower than expected print, then rising 6-7 bps on the news of the large retrospective revision to April’s print.   It is important to note that only about 15 bps of the June headline rate can be attributed to increases in the administered prices of fuel products (diesel, LPG, kerosene) witnessed at the end of June. Even absent this price increase, therefore, June inflation would have accelerated over that of May. The bulk of the fuel price increases will show up in the inflation rates of July and August.   Meanwhile, April headline inflation was revised up by a whopping 108 bps. While this is not surprising in light of the past revisions, what it suggests is that June inflation is likely to ultimately be revised up to over 10%, which would constitute the highest inflation rate in about a year. What it also suggests is that the new WPI series introduced last August suffers from the same phenomenon of large retrospective revisions that characterized the old index. It also debunks the notion that was perpetuated in some quarters last month that the series is gradually stabilizing and that the revisions are becoming smaller (March was revised up by 64 bps).     Monthly momentum of core inflation moderates   As alluded to above, one of the key reasons why the June inflation print came out less than expected, was a substantial moderation in the monthly momentum of non-food manufacturing inflation (deemed to be a proxy of core inflation by the RBI). Specifically, non-food manufacturing prices rose only 0.1 % m/m, sa in June compared to a monthly average of about 0.8-1 % over the last 6 months. On a year-on-year basis, however, the moderation was marginal, with core inflation printing at 7.2 % oya in June (still significantly higher than the RBI’s medium term indicative target) compared to 7.3 % in May.   It is, however, premature to conclude from one data point that manufacturing prices have stabilized on a sequential basis. For one, once the May and June data are revised it is conceivable that the moderation in non-food manufacturing inflation is less than the initial prints suggest – a phenomenon observed in some previous months. Second, the June manufacturing PMI output price index (a good leading indicator of core inflation) did suggest that manufacturing inflation would moderate in June. What it also showed, however, was that input price pressures ticked back up in June, suggesting that margins continue to be squeezed and the pressure for further output price increases remains in the system. As such, June may simply constitute a respite, rather than the start of a trend. Finally, the second round impacts of the increases in administered diesel prices (through higher transportation costs) are likely to pressure core inflation sequentially in July and August, though, admittedly this will be a one-off effect.     25 bps hike likely on July 26   While the RBI is likely to be encouraged by the sequential moderation of core inflation in June, it is too early to posit whether this trend will sustain, or is simply a temporary respite after sustained increases in manufacturing prices over the last few months. Furthermore, this will not necessarily be evident in the next month or two, either, since core inflation is likely to be pressured in the coming months just by the second round impacts of last months fuel price increases. While some indicators of economic activity (IP, PMI, motor vehicle sales) show signs of moderation, other indicators (non-oil imports, tax collections) continue to hold up. In sum, there is still not sufficient evidence of either a broad-based or a significant slowing of the economy to reverse core inflationary pressures on a sustained basis.   Furthermore, as pointed out above, even through the June print came out slightly less than expected, it still constitutes a meaningful acceleration over May. With the bulk of the fuel price increase yet to be captured by the WPI index, inflation is likely to accelerate into double digits over the next few months, and remain at elevated levels over the next quarter at least, even per the RBI’s own projections.   In light of this, and the fact that that the RBI has characterized its own stance as “firmly anti-inflationary” in the last review, we expect the central bank to hike policy rates by 25 bps at its quarterly review on July 26.