Markets watch RBI move as inflation rises

India's inflation, based on the Wholesale Price Index (WPI), increased marginally in the week ended January 12 due to higher edible oil prices, even as the Government failed to make up its mind on fuel price hike. The annual point-to-point inflation rose at a 3.83% rate in the second week of January as against the previous week's rise of 3.79%, the Commerce & Industry Ministry said. The rate matched average forecast of analysts and is the last reading before the Reserve Bank of India (RBI) reviews interest rates on Tuesday. The annual inflation rate was 6.15% during the year-ago period. Speculation has been rife in the bond market recently that with inflation under control and some moderation in economic growth, the RBI may be tempted to trim its short-term rates from a five-and-a-half-year high.

The Federal Reserve's surprise rate cut may also put some more pressure on the central bank to reduce borrowing costs. The RBI may also prune rates to discourage greater foreign inflows amid rising interest rate differential between local and US rates. The rising interest rate arbitrage between Indian and US rates could once again boost foreign capital flows, which could make it tough for the central bank to formulate monetary policy and manage money flows. Higher overseas inflows could also increase money supply and fuel inflation in Asia's third-largest economy. Some economists expect the RBI to maintain status quo on interest rates at its Jan. 29 meeting. The Fed rate cut may push capital inflows and the RBI may reduce rates after March depending on inflation and outlook on economic growth.