India’s Inflation Eases to Its Lowest Level in 26 Month; Food Prices Fall

"Usually prices rise in January, but that has not happened to such an extent this time. The manufacturing and core manufacturing inflation have slowed down more than expected," said A. Prasanna, an economist at ICICI Securities Primary Dealership in Mumbai.

"This has raised chances of a 25-basis point rate cut in March (rather) than in April. The rupee's rebound in January has also partially helped inflation to ease."

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The Reserve Bank of India (RBI) is widely expected to start cutting interest rates in the quarter beginning April 1, as it looks to stimulate an economy that is headed for its slowest growth in three years.

The central bank ran a 20-month interest rate tightening cycle until October to slow down inflation to 7 percent by March. Economists expect the RBI, during 2012, to cut its policy rate by 100 basis points from the current 8.5 percent, with a cut of 50 basis points in the April-June quarter.

COMING FEDERAL BUDGET A KEY

Federal bond yields and swap rates fell after the January inflation data on hopes of an early rate cut.

"This fall in core inflation bodes well to bring up the rate cut expectation," said Vivek Rajpal, an India strategist at Nomura in Mumbai. "Our base case remains April cut, (but) market should from hereon start assigning some probability to March rate cut."

In keeping its policy rate unchanged last month, the RBI cited risks to inflation from global crude oil prices and the weak rupee, as well as India's yawning fiscal deficit.

The rupee fell nearly 16 percent last year against the dollar, before rebounding about 7.5 percent this year.

The fiscal deficit, however, is widely expected to be almost a percentage point higher than the government's target of 4.6 percent of gross domestic product for the fiscal year ending March 31, largely reflecting a slowdown in economic growth.

"Despite growing odds for a March cut, the RBI might prefer to watch the mid-March budget before kick-starting the rate easing cycle in April," said Radhika Rao, an economist at Forecast Pte Ltd in Singapore. She expects the RBI to cut cash reserve requirements for banks at its March policy review.