Consumer Price Index (CPI) moderated to 4.20% in October from 4.39% in September 2016. Wholesale Price Index (WPI) moderated to 3.4% in October 2016 from 3.6% in the previous month. Both CPI and WPI moderated in October 2016, primarily led by further softening in food price inflation, which is along the expected lines. Retail food inflation moderated to 3.3% yoy in October 2016 from 3.96% in the previous month. This was because of a sharp decline in the prices of pulses together with a moderation in the prices of vegetables and fruits. Retail pulses inflation declined to 4.1% in October from 14.3% in September 2016 with the kharif crop harvest gradually coming into the market. Wholesale inflation in pulses moderated to 4.7% in October from 5.06% in the previous month. The more pronounced decline in retail pulses inflation is because wholesale prices had already reacted to the new arrival, as evidenced by the sharp decline in September pulses inflation over August 2016. Wholesale pulses inflation had dropped to 24% in September 2016 from 34.2% in the previous month.
Food items such as sugar, eggs, meat and fish still remain areas of concern, notwithstanding the declining trend in the overall food component in both wholesale and retail inflation. Cereals prices are another potential area of worry. Cereals inflation in the wholesale market softened to 6.13% in October from 9.51% in August 2016; however, it has increased to 4.4% in the retail market from 4.1% for the same months.
Ind-Ra believes that food inflation will remain soft in the coming months in the wake of a good kharif harvest and setting in of winter. However, the disruption caused by demonetisation of INR500 and INR1,000 notes could lead to some temporary spike in food inflation. Wholesale fuel inflation further increased to 6.2% in October 2016 from 5.6% in the previous month. This is a big jump from the 1.6% fuel inflation in August 2016. Wholesale manufactured food products inflation came in at 10.5% in October 2016, which is the fourth consecutive month of double-digit inflation since July 2016. This suggests although the moderation in cyclical components of food inflation such as fruits, vegetables and pulses has positively impacted food inflation, upside risks to inflation cannot be altogether ruled out.
The impact of government's measures is likely to be disinflationary as economic activity witnesses a downward bias. This may open up room for further monetary accommodation later, once the full impact of demonetisation of currency manifests. As a result, despite the recent surge in global bond yields, domestic bond yields have softened sharply (30bp-50bp) across the curve this week. The shorter end of bond curve is poised to benefit as banks prefer investing in short tenor assets while the system transitions to new currency notes. The longer end of the curve, while continuing to exhibit a softening bias, will be more reflective of global risk preferences and outlook on the US Fed rate trajectory.
Global volatilities and shift in risk preference have kept the rupee trading range wide - as investors internalise both global and domestic developments. The recent retail inflation reading does not significantly alter the domestic outlook. However, with increased probabilities of a Fed rate hike in the December 2016 policy - the dollar index has surged to 100.23 from 97.5 since 1 November 2016. This will keep the rupee trading with a weakening bias in the near term. Ind-Ra, however, believes that the better placed domestic fundamentals will aid resilience of rupee, compared to other emerging market currencies.
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