CPI inflation: A breather in sight

For a year that was feared to be marked by high inflation, FY11 turned out to be quite a pleasant surprise. The full-year number stood at 13.92 percent - below the central banks full-year projection of 14-14.5 percent it said it had expected earlier this year.
One major factor behind this slightly better-than-expected performance is the relative easing of food prices following the dreadful spike triggered by the floods at the start of the fiscal year.
Prices of both perishable and non-perishable food items have been on a decline lately. Prices of perishable items inflated by an average of 13.46 percent year-on-year in 4QFY11, down from 33.11 percent year-on-year in the quarter before. Similarly, that of perishable items also edged lower to an average of 16.66 percent year-on-year in the fourth quarter, from 16.84 percent year-on-year in the quarter before.
The combined effect of both, reduced food inflation to 16.26 percent year-on-year in the last quarter FY11, from 18.74 percent in the preceding three months. And this trend is expected to continue in the months ahead.
Leading up to December 2011, the high base effect can also be expected to keep inflation from going out of control. The fall in commodity prices especially that of oil is also going to be a supporting factor - one that will reflect in Julys CPI as well.
Moreover, better-than-expected performance on the part of FBR that not only met its revenue target but also surpassed it marginally has reportedly enabled the fiscal managers to keep their central bank borrowing much below the limits they had promised. This, in turn, can be expected to keep the monetary-induced inflation in check in the upcoming quarter.
Yet the CPI is likely to remain sticky within double-digits, albeit it is likely to stay within lower levels of the band.
The house rent index - that encapsulates nearly 24 percent of the CPI basket - continues steadily on its northward journey, nearly mirroring its historical cycle. On the other hand, the proposed increase in gas prices, as well as electricity tariffs, is also likely to keep prices inflating month after month.
The problem with the latter is that it also stokes inflationary expectations, in the absence of any clear-cut direction, and understating of the nature and extent of the hike in power tariffs.
But then again, given the historically populist stance adopted by the government, one can be too sure whether power tariffs will in fact be raised in accordance with what the IMF requires, or not.
Still, given the likely decline of food inflation, and reduction in government borrowing from the central bank, it wouldn be too optimistic for the market to expect a 50-100 bps cut in policy rates when the central bank meets next.
This is unless the central bank weighs heavily on the below-the-surface deterioration of the balance-of-payment account, where the current account showed a reversal in surplus in May, whereas the capital account continues to be weak in the wake of falling FDIs.