Rate cut unlikely as inflation breaches RBI's ceiling of 6%; market to see brief impact

"It was more or less expected that the inflation rate for December will breach the upper band of 6 percent, due to the rising vegetable prices. However, inflation rate of 7.35 percent is at the higher end," said Deepthi Mary Mathew an economist at Geojit Financial Services.

The slight improvement in core inflation could be attributed to the tariff hikes by the telecom operators, said Mathew.

How will the market read it?

Experts say there could be a brief impact on the market, considering the numbers are much above the RBI’s forecast.

However, the market will move ahead considering the retrospective effect of a sudden jump in food and oil prices, which are anticipated to normalize in the coming months.

At this juncture, experts say the hope around the Union Budget, better Q3 numbers and developments on the US- Iran and US-China front are more important triggers for the market.

"The market will focus more on the expected reforms measures in the upcoming Union Budget and possible improvement in the trajectory of corporate earnings growth as per the Q3FY20 earnings preview," said Vinod Nair, Head of Research at Geojit Financial Services.

What are the top brokerages saying?

Deutsche Bank: Rate cuts, if any, is likely to be only in Q3 or Q4 of FY21. Inflation may average about 5.9 percent in January-March 2020 and closer to 4.9 percent in the first half of FY21 and may fall sharply in October-December to 3.1 percent, with December 2020 print closer to 2 percent.

Morgan Stanley: Inflation readings may remain around 7 percent over the next 3-4 months and the effect of telecom tariff hikes may linger for the next 1-2 months. Low base from the last year will also support an increase in year-on-year (YoY) readings. Core inflation is expected to remain subdued at 3.7-3.8 percent. Subdued core inflation is reflecting still-weak aggregate demand.

Phillip Capital: Deviation between the rural and urban CPI declined and a sharp negative surprise came from vegetable inflation. We maintain our stance of the status quo on interest rates as inflation is expected to remain elevated for the rest of the financial year. The extent of food inflation reversal is the key.

Nomura: Inflation is likely to remain similarly elevated in January and we expect RBI to continue with the status quo at February meet. RBI should deliver a 25 bps rate cut by Q2 of FY21.

No rate cut for now is almost certain

Most analysts and economists think RBI will hold the rates in February, and would also keep a close watch on the fiscal deficit figures, before resuming the rate cuts.

RBI MPC will also keep in mind that food inflation might subside in the coming months, but the pressure on crude oil prices due to geopolitical tensions is an area of concern.

"With the Central Bank following inflation targeting regime, it is unlikely that the RBI will resume rate cuts in February. Though food inflation might subside in the coming months, pressure on crude oil due to geopolitical tensions is a concern for the Central Bank. RBI will also keep a close watch on the fiscal deficit figures," said Nair of Geojit Financial Services.

Nikhil Gupta, Chief Economist, Motilal Oswal Financial Services finds food inflation prints worrying and said even if vegetable prices decline 5 percent month-on-month (MoM) over the next two months, headline inflation will stay at 7 percent.

"What worries us is that headline inflation is likely to stay above 5 percent in CY2020, which confirms that rate cuts are a thing of past now," Gupta said.

Brokerage firm Emkay Global Securities believes the RBI may maintain its stance while maintaining a pause on the rate cut.

"Real rates have now turned negative at 220bps and the possibility of fiscal slippage in FY20 is a signal that the rate easing cycle has come to an end. However, we believe that it will be too soon for the RBI to change its stance to tightening as the inflation is more or less transient in nature amid the wide output gap," Emkay Global said.

In its December policy review, the Reserve Bank of India (RBI) maintained status quo, for the first time this year, on higher inflation expectations even as economic growth is likely to weaken going ahead.

The RBI also revised downwards its GDP growth target for the current financial year from 6.1 percent in the October policy to 5 percent.

The economy still on shaky grounds

The fresh trends are giving mixed pictures. Recent data showed IIP turned positive, but the auto sales numbers dipped in December while banks' risk aversion is creating a serious liquidity squeeze in the market. Experts say, don't expect a recovery anytime soon in the economy.

"We are getting a mixed picture of the economy. On the positive side, IIP has turned positive after three months of contraction, the PMI for both manufacturing and services sector has marked improvement. On the other hand, automobile sales dipped in December," said Nair of Geojit Financial Services.

"Within IIP, primary goods, capital goods, construction goods and consumer durables are still in the negative territory. And even with 135 bps cumulative rate cut, slow credit growth is an area of concern. In such a scenario, the slowdown in the economy could persist for a few more quarters, and growth will start to pick up in FY21," Nair said.

Even the uptick in IIP was due to the lower base and economists said there was nothing to cheer in the improved IIP numbers.

"Slow movement upwards more due to statistical base effects. Post-harvest or festival season i.e. September 2020 will be the time to watch for. Meanwhile, growth can be prodded by the government which will be the main spender till monsoon time," said Madan Sabnavis, Chief Economist of CARE Ratings.