Rate cut could be in the offing as CPI hits 17-month low: Kotak

Kotak Institutional Equities

Positive macro data points towards a rate cut in the near future. The November CPI inflation of 2.3 percent affirms that the MPC would now tread towards a softening stance in the upcoming meetings.

While we continue to expect a shift in stance to ‘neutral’ before the onset of rate cuts, we acknowledge that the recent downward surprise to inflation has increased the probability of a rate cut in the February meeting itself.

We now expect 50 bps of a rate cut in CY2019 (likely in H12CY019). CPI inflation eased to 2.33 percent in November (Consensus: 2.58 percent) compared to an upward revised print of 3.4 percent in October.

Even as the base effect was favourable for a lower print, the sharp contraction of 2.6 percent in food inflation, led by vegetables, pulses, eggs, and sugar triggered the decline.

Core inflation softens significantly

Core inflation moderated to 5.7 percent in November (6.2 percent in September) driven by softening inflation across housing, health, and personal care.

Excise cuts and the recent correction in oil prices have begun to weigh on transport and communication segment, moderating to 6.1 percent (7.7 percent in October). On a sequential basis, core inflation stayed flat after expanding 1 percent MoM in October.

Kotak Institutional Equities expects core inflation to average 5.6 percent between December 2018 and March 2019 compared to 6.1 percent in 8MFY19.

IIP growth strengthens to an 11-month high:

IIP growth strengthened to 8.1 percent in October (Kotak: 4.8 percent, Consensus: 6 percent) compared to 4.5 percent in September. The uptick was broad-based, caused by stronger growth of 7.9 percent in manufacturing (4.6 percent in October), 10.8 percent in electricity (8.2 percent in October) and 7 percent in mining and quarrying (0.1 percent in September).

Capital goods and infrastructure/construction posted strong gains of 16.8 percent and 8.7 percent, respectively. Growth in consumer goods also went up sharply, primarily aided by a favourable base in the consumer durables segment, which grew by 17.6 percent. We do not expect this trend in IIP to sustain as indicated by softening lead indicators.

RBI likely to change stance in February followed by 50 bps rate cuts

The continued downward surprise to the inflation trajectory has created the perfect condition for a softening bias by the MPC. The November inflation outturn has been around 40 bps lower than RBI’s recently downwardly revised H2FY19 range of 2.7-3.2 percent.

Kotak Institutional Equities expects the inflation to remain below 4 percent for the next eight months. With the next two readings also expected to be below 3 percent, we expect the MPC to change its stance to ‘neutral’ in February.

While the domestic brokerage firm expects a shift in stance before the onset of rate cuts, it acknowledges that the recent downward surprise to inflation has increased the probability of a rate cut in the February meeting itself.

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