Low inflation to encourage RBI to cut rates next week

Bengaluru: The Reserve Bank of India (RBI) is expected to cut interest rates when it meets on August 2, responding to an inflation rate running well below target, but an improving economy is likely to keep it on the sidelines for a long time thereafter, a Reuters poll showed.

A significant moderation in retail inflation over the past three months has reinforced calls for further monetary policy easing from the central bank, which changed its stance to neutral from accommodative at the start of the year.

Weak consumer spending following the government`s ban on high-value currency notes late last year as well as lower food prices have kept inflation below the RBI`s 4 percent mid-term target for the past eight months. 

Inflation eased to its slowest pace in more than five years in June. 

"The recent sharp decline in inflation has clearly caught the RBI by surprise. Clearly, the stage is set for another rate cut," wrote Kunal Kumar Kundu of Societe Generale. 

"Normal monsoon, falling crude prices, weak capacity utilisation and a strong currency all suggest that India`s headline inflation does not face much tailwind."

Forty of 56 economists polled July 24-27 predicted the RBI cutting its repo rate by a quarter percentage point to 6.00 percent on Wednesday. Two respondents said the central bank would cut the rate by 50 basis points. 

Only 14 respondents predicted no change.

The RBI is also expected to trim the reverse repo rate by an equal measure to 5.75 percent. The central bank last cut its key interest rate in October 2016.

After the expected reduction on Aug. 2, however, the RBI is forecast to stand pat on policy at least until 2019 because economic growth is set to accelerate. Indian stocks are trading at a record high, partly in anticipation of that.

A separate Reuters poll taken last week showed the Indian economy will expand 7.3 percent this fiscal year, reclaiming its position as the fastest growing major global economy, partly propelled by benefits from a new tax system. 

A few also said the new goods and services tax - which replaces multiple taxes levied by central and state governments in order to facilitate collection and ease of doing business - might lead to an increase in services prices.

That could push up core inflation, which has remained above 4 percent for years, and has been a key concern for the RBI.

"This could be the final rate cut in the current fiscal (year) as inflation seems to bottom out ... the inflation trajectory may witness (an) upward trend from July 2017," said Himanshu Varshney, research analyst at AK Capital.

Inflation is forecast to rise to 4.7 percent next year, according to the latest Reuters poll.