India’s headline inflation declined to 7.18 percent in December from 7.24 percent in November – its slowest pace in three years -- raising the hopes that the Reserve Bank of India (RBI) would cut the interest rates in its review meeting later this month.

The Wholesale Price Index (WPI) declined as the prices of fuel and manufactured items cooled moderately in November, compared to those in the previous month.

The unexpected decline in the WPI has surprised the analysts who expected it to rise 7.40 percent.  

In its October review, the RBI projected the December inflation to be around 8 percent.   

The food articles index declined 0.5 percent due to the lower prices of coffee, fruits and vegetables and marine products. However, the prices of food items like bajra, maize, rice, tea, ragi and poultry went up during the period.  

The manufactured products index remained unchanged at 5.41 percent from that in November.

In the fuel and power category, inflation moderated to 9.38 percent in December from 14.98 percent in the same month last year.  

Core inflation fell to 4.2 percent in December from 4.5 percent in November.

The moderation in the WPI is expected to boost the positive sentiment in the market, as cooling of inflation is expected to prompt the RBI to consider the interest rate cuts. The Bombay Stock Exchange’s Sensex and the National Stock Exchange’s Nifty rose over 1 percent after the release of the inflation data.

"Based on this data, we expect the RBI (Reserve bank of India) to cut rates by 25 basis points " A Prasanna, economist at ICICI Securities Primary Dealership in Mumbai, was quoted as saying by Reuters.

“If core inflation remains below 5 percent, it increases the chance of the central bank cutting rates by 25 basis point in January,” Rahul Bajoria, economist at Barclays Capital in Singapore, was quoted as saying in a Reuters report.

There have been strong pleas from the market players and the industry to cut the interest rates to help the struggling economy recover, but the RBI has refused to ease the monetary policy, stating that the inflation is well above the comfort levels.

The Indian economy, which is passing through one of its slowest growth phases in a decade, is expected to bottom out in the fourth quarter of 2012-2013 financial years, according to the analysts at HSBC.

Retail Inflation Accelerates

India’s retail inflation -- both rural and urban combined -- rose to 10.56 percent in December, according to the data released by the government Monday.

“The corresponding inflation rates (provisional) for rural and urban areas are 10.74 percent and 10.42 percent respectively. Inflation rates (final) for rural, urban and combined for November 2012 are 9.97 percent, 9.69 percent and 9.90 percent respectively,” the data said.

The RBI’s monetary policy decisions are based on the Whole Price Inflation and not on the Consumer Price Inflation.

The central bank’s next policy meeting will be held Jan 29.