The continued deflation in WPI is not surprising given the heavy bias of tradables in its composition. The sharp disinflationary trend in global commodities in the past few months has been feeding into WPI which is likely to continue in the near term. The RBI's focus will be on CPI dynamics, fallout of Yuan devaluation and FOMC decision. If global volatility remains benign, lower inflation prints will strengthen the case for a rate cut on Sep 29. We do not assign much probability of an inter-meeting cut as key event risks are yet to play out.
WPI to be in deflation till November
July headline WPI inflation contracted 4.05% against (-)2.4% in June. This should not be a surprise as WPI is heavily weighted towards tradable goods. The sharp deceleration in headline inflation was driven by contraction in energy (petrol and diesel) and manufactured goods (chemicals and base metals). Based on our estimates, we expect WPI to be in the red till November reaching a trough in August. Even as favorable base effect dissipates after August, low commodity prices (crude and metals) will keep headline inflation depressed. We expect August inflation at (-)4.6% with March 2016 inflation moving up to ~2.0%. The RBI Governor has been skeptical of attaching too much importance to WPI inflation as a guiding factor and also how the markets treat the metric for further analysis (see excerpts below).
Sequential uptick in some food articles; energy prices continue to move lower
Primary food inflation in July eased to (-)1.16% from 2.88% in June even as cereals and pulses registered a sequential increase. Vegetables and fruits registered a sequential fall contrary to the direction of CPI inflation. Energy inflation was at (-)-12.8% with the sequential decrease reflecting the fall in pump prices in July. In July, petrol and diesel fell by (-)1.4% and (-)4.1%. In August decrease in fuel prices was larger which will feed into WPI.
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Base effect continues to bode well for core inflation
Core inflation continued with its secular decline, contracting 1.4% in July after (-)0.9% in June, reflecting soft global commodity prices. Chemicals and chemical products (crude derivative) contracted 1.7% while basic metals and alloys contracted by 5.9% yoy. Our core WPI inflation trajectory hints at continued deflationary trend helped by favorable base effect, even as we expect marginal increase sequentially. We expect core WPI inflation to climb back to ~1.2% by March 2016.
CPI trajectory and global stability will decide September rate cut
RBI's main focus will be CPI inflation. WPI inflation provides room to cut rates without much worry about the effect on imported inflation. We highlighted in our CPI data comment that food inflation and sowing activity have remained comfortable overall despite subpar monsoons. Therefore, the only potential impediment for a September rate cut appears to be uncertainty over Fed's expected September lift-off. If global markets remain well-behaved after Fed's lift-off, we think RBI should be able to move ahead with the 25 bps rate cut. Overall, we now see room for further 25-50 bps cut through FY2016.
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