India: March headline inflation predictably re-accelerates, and the stubbornness of core is worrying
We had expected that, after decelerating for three straight months, CPI and WPI inflation would likely re-accelerate in March on the back of firming food prices and sticky core inflation (see. “India Monthly Data Outlook: April 2014,” MorganMarkets, April 7). As it turned out, headline CPI rose to 8.3% in March from 8% in February – exactly in line with expectations (JP Morgan and Consensus: 8.3%). And, in fact, WPI reaccelerated more than markets had expected, printing at 5.7% oya (JP Morgan 5.4%, Consensus 5.2%), hurt by an unfavourable base effect and the fact that food prices increased more than high-frequency data had suggested.
The core of the problem
But even as the dynamics of headline inflation were broadly anticipated, the details were worrying. The momentum of core CPI is showing no signs of abating and rose to 0.8% m/m, sa in March on the back of off a slightly-downward-revised February core print. Therefore, even as the year-on-year core CPI printed at 7.9% -- and may gave the impression of a modest softening over the last two months – it is masking a more elevated underlying momentum, with the 3m/3m, saar rising to 8.4% in March, the highest since November 2013. Furthermore, core price pressures were not narrowly focused with the momentum of housing, education, transport and communication, and household requisites remaining elevated and/or firming up. More generally, the stubbornness of core CPI is evident from the fact that, despite a weakening of growth, it has been close to or above 8% for 27 consecutive months.
Such worries will be reinforced by the fact that core WPI prices also reaccelerated, though not to threatening levels as yet. After remaining very contained over the last two months, core prices rose 0.3% m/m, sa in March, consistent with a year-on-year March print of 3.5% oya. But markets were spooked by the fact that core WPI jumped to 3.5% in March from 3.1% in February, causing the benchmark 10Y government bond to initially sell-off before recovering and inducing equity markets – riding a wave of euphoria in recent weeks -- to correct on worries of a stickier-than-expected inflation path. Market worries were likely predicated on the fear that if core WPI inflation were to reaccelerate it does not bode well for already-elevated core CPI inflation.
We have long maintained (see, “India in 2014: five questions that keep us awake, Jan 2014,” MorganMarkets, January 28th) that the fact that core prices have not collapsed in the face of weak growth is a worrying sign. And this suggests, that if demand actually accelerates in the coming months, core inflation could see significant upward pressures as firms rush to normalize margins.
Food prices get back to their old ways
In line with expectations, food prices increased sequentially in March, as the vegetable price correction plateaued and other food prices continued to tick up. CPI food prices ticked up 0.5% in March consistent with the high-frequency data, but WPI food prices rose more sharply (1.1%) than daily price date had suggested – causing a small upward surprise to the headline rate. As it turns out, food prices seem to be firming at a faster pace in the first half of April, and therefore could pressure the headline rate even further this month.
Dynamics consistent with our baseline forecast of more tightening
To be sure, there are large favourable base effects that kick in from June to November which will temporarily pull down year-on-year CPI and WPI inflation. But we believe the RBI will look through this temporary phenomenon. Instead, if the underlying sequential momentum of inflation continues to firm at the pace seen in March (+0.7% m/m, sa for headline CPI) – with food prices mean-reverting and core inflation being pressured by the growth cycle bottoming out -- more monetary tightening is likely later in the year – consistent with our baseline call -- to ensure the RBI’s January 2015 headline CPI target of 8% is not under threat.
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