New Delhi: India's headline inflation unexpectedly accelerated in May, underlining the expectation the Reserve Bank would raise rates before its scheduled July review despite concerns over Europe's debt crisis.
The data came along with a sharp upward revision of March's reading and on the heels of April manufacturing output matching its fastest pace in 15 years, indicating strong growth and rising inflationary pressures in Asia's third largest economy.
"This increases the likelihood of an intermeeting rate hike from the RBI (Reserve Bank of India) as inflationary pressures are really showing up," Sebastien Barbe, the Hong Kong-based head of emerging markets research and strategy at Credit Agricole.
"It seems like the markets are also now less worried about the situation in Europe, so the RBI may be less reluctant to tighten before July."
The 10-year bond yield rose 6 basis points to 7.67 per cent after the data, while one-year indexed swap rates also rose 5 basis point. Stocks trimmed gains.
The one-year overnight indexed swap rate has risen over 50 basis points from a more than 5-month low of 4.71 per cent touched in early May on concerns over tight liquidity in the banking system and expectations of higher policy rates.
Many analysts had earlier been expecting the RBI to wait till its July 27 review meeting to raise rates, expecting Europe's woes and expected tight market liquidity to stay its hand. That view is now changing.
"RBI will increase the frequency of its baby steps and we expect some tightening measures in June itself and a repetition of those in the July policy," Rupa Rege Nitsure, chief economist at Bank of Baroda in Mumbai, said.
"Baby steps" to normalise monetary policy is what the RBI has said is its preferred choice of action, but it has also kept open the option of a rate hike ahead of the July review to combat inflation which it deems "worrisome."
The wholesale price index (WPI) rose an annual 10.16 percent in May, higher than the median forecast for 9.56 per cent in a Reuters' poll and April's 9.59 per cent.
In a sign the May reading could be an underestimate, March inflation was revised to 11.04 per cent from the earlier estimate of 9.90 per cent. Recent WPI data have been similarly revised up.
Stubbornly high inflation poses a political risk for the Congress party-led government, with voter sentiment possibly turning against it before eight state elections in 2010 and 2011.
It would also dampen enthusiasm for reforms, such as a keenly awaited freeing up of retail fuel prices, crucial to improving public finances and stop state-run fuel retailers from bleeding.
The government deferred last week taking a decision on freeing fuel prices, worried about political opposition and the impact on prices.
Policymakers expect inflation to ease on better prospects for crops from good monsoon rains. But a hike in fuel prices, which is being discussed by the government, could push it up, an adviser has said.
Finance Secretary Ashok Chawla told Reuters ahead of the data release that inflation was grounded in supply-side problems and would come down to 5-6 per cent by December.
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