Markets came to grasp with sharply higher inflation and tepid recovery in factory output this week. We think the pace of the recovery in manufacturing will quicken as indicated by August manufacturing PMI. Besides, some sluggishness in the near term can be expected due to large discounted sales pre-GST implementation.

Early indications from producers of coolers suggests that Onam and Ganpathy festive consumption trends were subdued, even after considering the already lean season for such products. This could be due to early buying given nearness to pre-GST discounts. The real litmus test for the health of consumption lies in the months ahead as the economy gears up for Diwali. We will have our ears to the ground on this one given potential headwinds from low farm sector realization so far and urban consumer sentiment weakened by employment outlook.

In some good news, reasonable sowing data despite erratic rains has helped to assuage concerns about droughts in several districts.The government quickly dismissed reports that 225 districts were reeling under drought like conditions.

Positive sowing data and recent rainfall trends are also beneficial for the inflation outlook since CPI has more than doubled from June mostly led by a spike in the prices of fresh foods like Tomatoes & Onions. We think much of this rise is due to temporary or one-off factors. For example, if rains were evenly distributed, pay commission HRA was not awarded, geo-political tensions did not rise and GST was not implemented, headline CPI inflation would have still been under 2%.

At this point, given sluggish growth, we don’t see any factor that can pull up inflation durably over the next 12 months, except HRA which is statistical and can be ignored. Even if other inflationary events crop up, the RBI’s 4% CPI target is secure for the foreseeable future since sufficient elbow room will develop as these temporary factors correct. The case for another 25bp rate cut remains intact.