A transient spike in inflation

 A transient spike in inflation

CPI inflation in June increased to 5.1% from 4.8% in May due to a spike in vegetable prices. Prior to this price increase, the June CPI inflation print was expected at around 4.4%. We expect this spike to be transient and reverse 2-3 months later. We maintain our FY2025 average CPI inflation estimate at 4.5%. We continue with our call for a shallow rate cut cycle, starting in the December policy.

Food inflation spikes up in June due to vegetable prices

The June CPI inflation was at 5.1% (Kotak: 5%), higher than the May print of 4.8%, but was earlier expected to be around 4.4%. The sharp increase in vegetable prices in the second half of June pushed up food inflation to 8.4% (2.7% mom increase, May: 7.9% yoy). Durable food inflation fell to 5.9% (May: 6.3%) (Exhibits 1-4).

Core inflation has likely troughed out

Core inflation (CPI excl. food, beverages and fuel) at 3.1% was in line with the May print. Core CPI increased 0.1% mom (May: 0.3% mom). Various core inflation metrics troughing out around 3% will continue to strengthen the case for a rate cut for a few MPC members (Exhibit 5). We expect core inflation to average 3.9% in FY2025.

Inflation likely to hover around 4.5% for most of the year

The vegetable price spike should be transient and reverse over the next 2-3 months. We estimate only a gradual moderation in headline inflation toward the RBI’s 4% target. While inflation has panned out broadly in line with our expectations, we remain wary of the last-mile disinflation pace. Risks will persist from (1) commodity price spikes and subsequent transmission to finished goods and (2) adverse weather impacting food inflation (as seen in June). We maintain our FY2025 average CPI inflation estimate at 4.5% (Exhibit 6).

IIP growth remains steady in May

IIP growth in May was at 5.9% (April: 5.0%). According to the sectoral classification, manufacturing activity increased 4.6% (April: 3.9%), mining increased 6.6% (6.8%) and electricity production increased 13.7% (10.2%) (Exhibit 7). In terms of the use-based classification, all categories registered positive growth, except for consumer non-durables (Exhibit 8).

Maintain our call for a shallow rate cut cycle

The domestic growth-inflation dynamics will support the RBI, targeting the 4% inflation target on a durable basis. The global policy cycle should also be conducive, even with an asynchronous rate cut cycle—markets are pricing in two rate cuts by the Fed in CY2024, starting in September. Based on our domestic and global economic conditions expectations, we maintain our call for a shallow rate cut cycle (75-100 bps) from the December policy and stance changing either in October or along with the rate action.