Three reasons why BofA-ML thinks RBI should go for a rate cut in August

Bank of America Merrill Lynch (BofA-ML) expects Reserve Bank of India (RBI) to cut interest rates by 25 basis points in its third bi-monthly monetary policy to be announced on August 09.

In the June policy review meet, RBI Governor Raghuram Rajan kept interest rates intact, citing rising inflationary pressure, but hinted at a reduction later this year if good monsoon helps ease inflation.

Rajan, whose term ends in September 4, has reduced policy rates by 150 bps since January.

The global brokerage firm has listed following three reasons as to why RBI should consider reducing rates in August:

1) Rains to douse pulses price inflation

Rains are currently running 2 per cent above normal, and if the trend continues, it will help control the pulses price inflation setting stage for RBI to meet its 5 per cent inflation target for the March 2017.

Pulses inflation is currently running at 27 per cent on a poor summer rabi crop.

"With good rains, pulses' sowing for the kharif season has jumped 39 per cent above last year's sowing. This should pull down pulses prices by 20 per cent and cool CPI inflation to 5.1 per cent by March," BofA-ML said in a research note.

A 5 per cent change in pulses prices swings Consumer Price Inflation (CPI) by 12 bps.

2) June core-CPI inflation softens

June core-CPI inflation has softened to 4.8 per cent from 5 per cent last month with poor growth curtailing pricing power. Core inflation brings out the clearer picture of inflation as it excludes certain products such as those in the food and energy sectors that face volatile price movements.

3) High lending rates drag IIP

Industrial output, measured in terms of the Index of Industrial Production (IIP) grew at a measly 1.2 per cent in May, mainly due to an uptick in consumer durables output. It had expanded by 2.5 per cent in May last year. The government believes high lending rates dissuade corporate to kick off new businesses, thus hampering  industrial activity in the economy.