Inflation lags forecasts; RBI seen holding rates

Posted 10 22 2009 3:46PM

NEW DELHI (Reuters) – India's headline inflation rose at a slower-than-expected pace at the start of October as food prices fell, giving the Reserve Bank of India added room to maintain its easy monetary policy and focus on growth.

The widely watched wholesale price index rose by 0.92 percent in the 12 months to Oct. 3, below a forecast of 1.46 percent but picking up from the previous week's 0.7 percent.

"Over the last couple of weeks this data has been coming in below consensus, and this reassures us that inflationary expectations, which were building up, may now be assuaged," said Atsi Sheth, chief economist at Reliance Equities in Mumbai.

"We still expect inflation to continue rising, however we don't believe the rise will be worrying enough for the RBI to tighten aggressively over the next 12-month period," she said.

Investors backed off expectations for an imminent tightening in monetary policy, with the benchmark 5-year interest rate swap easing from the day's highs after the inflation figure was released.

The benchmark 10-year government bond yield fell 1 basis point to 7.36 percent, but traders were wary of adding positions ahead of Friday's bond sale.

Stocks ended 0.21 percent lower after earlier marking a fresh 17-month high, as export-focused outsourcing firms were weighed down by a strengthening rupee .

For a graphic on inflation, click: http://graphics.thomsonreuters.com/109/IN_INFL1009.gif

FOOD, FUEL PRICES FALL IN WEEK

Prices of food, fuel and manufactured products in Asia's third-largest economy all fell on a weekly basis, which will give comfort to policymakers ahead of the Reserve Bank of India's (RBI) monetary policy review on October 27.

"While some moderation was anticipated in line with lower prices of energy-related products, the decline in food article prices is welcome," said JPMorgan Chase economist Gunjan Gulati.

Analysts expect the RBI to leave interest rates unchanged although some expect it to take steps to mop up excess liquidity in the financial system as risk-seeking capital flows into India.

RBI Governor Duvvuri Subbarao has said there was broad agreement that India needs to retreat from its easy monetary stance, but he has also warned of the risks in mistiming such a move.

For a graphic on India's growth, inflation and benchmark interest rates for the past 5 years click: http://graphics.thomsonreuters.com/109/IN_GDPINF1009.gif

Top officials including Prime Minister Manmohan Singh have repeatedly outlined the need to continue with fiscal stimulus and an accommodative monetary stance to encourage growth, which slowed last year to 6.7 percent after three straight years of 9 percent or more.

India's worst monsoon since 1972 was followed by floods in parts of the country, damaging crops and pushing up prices of food items in the latest data by 13.34 percent from a year earlier.

Faster industrial expansion, reflecting rising consumer demand, is also expected to fan inflation.

Morgan Stanley this week lifted its forecast for Indian growth in the current fiscal year to 6.4 percent from 5.8 percent after industrial output was surprisingly robust, and expects the RBI to begin raising interest rates in January.

INFLATION, RATE HIKES LOOM

Many analysts expect inflation to surpass the central bank's comfort level of 5 percent before the end of fiscal 2009/10 on March 31.

The WPI has already risen close to 6 percent from March 28, the last reading of the 2008/09 fiscal year, and annual consumer price inflation in August stood at 11.72 percent.

"As far as the core inflation is concerned, we still expect the demand side inflation to pick up in the next few months," said Nomura economist Sonal Varma, who expects the RBI to begin raising rates in January.

"RBI's target of 5 percent (inflation) by March still looks unachievable and some upward revision in the October policy is likely," she said.

The central bank left its key policy rate unchanged at its last quarterly review after cutting it by 425 basis points to 4.75 percent between October 2008 and April.

(Writing by Tony Munroe, Editing by Jarshad Kakkrakandy)