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CPI inflation may average 5.3% in 2017; rate cut likely: Nomura

CPI inflation is likely to average around 5.3% in 2017, up from 5.1% in 2016, but the RBI might still cut repo rate by 25 bps in the first quarter of next year, says a Nomura report.

According to the Japanese financial services major, 2017 could well be another year of ‘sticky’ inflation that might breach the 6% mark during the fourth quarter of 2017.

“We expect headline CPI inflation to average 5.3% in 2017, up from 5.1% in 2016 and 4.9% in 2015,” Nomura said in a research note.

The report said, the underlying inflation is expected to remain sticky following the GST implementation, as higher taxes on services and the risk that manufacturers do not pass on the lower tax benefit to consumers could add 10-20 bps to headline CPI.

Additionally, the impending hike in house rent allowances due to the seventh pay commission recommendations can add 100-150 bps to headline CPI inflation, it said.

“We expect CPI inflation to average 4.9% in the first half of 2017, but at a much higher 5.8% in the second half of 2017, owing to adverse base effects, with 6% likely to be breached in the fourth quarter,” the report said.

Though Nomura’s inflation projections suggest that underlying inflation will remain around 5%, yet, it expects rate cuts.

“On monetary policy, we expect the RBI to deliver a final 25 bps rate cut in Q1 2017 (February), lowering the repo rate to 6%, but stay on hold thereafter, as inflation should move sharply higher in second half of 2017,” Nomura said.

The report noted that while demonetization has lowered perishable goods prices in the short term, it may not result in any sustained medium-term impact.

Moreover, nominal rural wages are expected to rise on account of the recent increase in minimum wages and higher MSPs. Rural wages has a high correlation with CPI inflation.

Besides, “the RBI’s monetary policy stance has changed from restrictive in 2015 to neutral/accommodative since mid-2016, which is another reason why the pace of disinflation should taper off,” Nomura added.