India's headline inflation picked up in February on higher fuel costs but another measure of price pressure cooled, reinforcing expectations that the RBI will deliver a rate cut next week.
The wholesale price index (WPI), the main inflation indicator, rose an annual 6.84 percent in February, higher than the 6.54 percent rise estimated by analysts. Wholesale prices rose 6.62 percent in January.
But non-food manufacturing inflation, which the RBI uses to gauge demand-driven price pressures slowed to 3.8 percent in February, the weakest pace since March 2010.
Rupa Rege Nitsure, chief economist at Bank of Baroda, said the inflation data showed a considerable slowdown in consumer demand, which should help keep inflation in check.
"Today's inflation data combined with continuous weakness in the real economic activities, in my opinion, would trigger the RBI to cut rates by at least 25 basis points on Tuesday."
The Reserve Bank of India, which has faced intense pressure from industry and government to loosen monetary conditions to help arrest the worst economic slowdown in a decade, cut its key lending rate by 25 basis points to 7.75 percent in January after leaving rates on hold for nine months.
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Hopes for a further cut at its policy review on March 19 have risen after economic growth slipped below 5 percent in the December quarter and Finance Minister P. Chidambaram pledged to rein in the fiscal deficit at 4.8 percent of gross domestic product in the year to end-March 2014.
Those expectations were further bolstered by Governor Duvvuri Subbarao's comments overnight that the 2013/14 budget unveiled last month will have a "softening impact" on price growth.
Bond traders read Subbarao's comments as an endorsement of the government's efforts to reduce its fiscal deficit, which he has previously said is a necessary condition to bring down interest rates, which are among the highest in major emerging economies.
Soon after the data, the benchmark 10-year bond yield fell 4 basis points to 7.86 percent on expectations that softer core inflation would give the central room to lower borrowing costs.
"Though the headline number is still high, the break-up (detail) shows that inflation will continue to ease going ahead and along with the government's fiscal consolidation efforts, there is even more reason to expect RBI to cut rates in March and for some more time going ahead," said Rahul Bajoria, regional economist at Barclays Capital.
HIGH FOOD PRICES
Fuel prices rose an annual 10.47 percent, faster than a 7.06 percent on-year rise in January. Manufacturing goods inflation dropped to 4.51 percent in February from 4.81 percent a month ago.
Food inflation also slowed down to 11.38 percent during the month from 11.88 percent in January. However, it stayed in double-digits for the third straight month, and has tempered expectations of any aggressive monetary easing.
Data on Tuesday showed that higher prices of food items pushed up consumer price inflation to 10.91 percent in February from 10.79 percent a month ago.
Slowing economic growth is equally a major worry for the Congress-led coalition government as it gears up for a general election due by May 2014.
Not only is the slowdown limiting employment opportunities for India's burgeoning population, it is also making it tougher for Prime Minister Manmohan Singh to fund his flagship welfare programmes.
India's GDP is on track to post its slowest gain in a decade at around 5 percent for the fiscal year that ends in March.