India's retail inflation eased for a second consecutive month in September, but the risks of price shocks from poor monsoon rains and oil are expected to prevent the central bank from cutting interest rates soon.
Consumer prices rose a slower-than-expected 6.46% from a year earlier, the lowest since figures were first published in January 2012. Slowing food inflation and a favourable statistical base drove the decline, government data showed on Monday.
In August, retail prices rose 7.73% year on year.
Lower prices should cheer Prime Minister Narendra Modi, who won the strongest electoral mandate in 30 years in May on promises to control inflation and pull India's economy out of its most protracted slowdown since the 1980s.
India has long struggled with soaring prices, particularly those for food. Food inflation dropped last month to 7.67% from 9.35% in August.
Encouragingly, core inflation slowed to 5.9% from 6.9% in August, suggesting demand-driven price pressures are weakening.
"With core inflation coming off incrementally, Reserve Bank of India (RBI)'s comments on controlling inflation may get more confident," said A Prasanna, an economist at ICICI Securities Primary Dealership.
Wholesale prices data due on Tuesday at 0630 GMT is expected to offer further evidence that inflationary pressures are waning. The wholesale price index (WPI) probably rose 3.3% in September, its slowest pace in nearly five years, compared with a 3.74% annual gain in August.
The RBI is nevertheless expected to keep interest rates on hold until the April-June quarter, concerned that poor monsoon rains and geopolitical tensions that affect oil could drive up prices.
"This doesn't materially change the probability of any rate cut in the near term," Prasanna said.
The RBI sent a strong signal last month that it would hold off cutting rates until it was confident that consumer inflation could be reduced to a target of 6% by January 2016.
Persistently high inflation is also weighing on a nascent economic recovery, crimping consumer demand which powers nearly 60 percent of Asia's third-largest economy.
Consumer goods output, a proxy for consumer demand, has grown in just two of the last 20 months. It fell an annual 6.9% in August, dragging down overall industrial production growth to a sharply lower than expected 0.4%.
Friday's dismal industrial figures have cast a shadow on the sustainability of the pace of recovery shown by the economy in the April-June quarter, when it grew 5.7 percent year-on-year, its fastest pace in 2-1/2 years.
That performance had raised hopes that India's prolonged economic slump was finally over and that growth could reach as much as 6 percent in the fiscal year to March 2015 - sharply higher from below 5 percent in the last two years.
JP Morgan cut its growth estimate for this fiscal year to 5.1% from 5.3% after the industrial output data.
Apart from a favourable statistical base, falling global crude prices are expected to help lower headline inflation.
Brent crude oil fell below $88 a barrel on Monday, its lowest in almost four years. Since India imports more than 70% of its oil, every $10 a barrel fall in global prices should lower retail inflation by 20 basis points.
But there remains a risk that oil prices could flare up again due to tensions in the Middle East or Ukraine.
As well as a prospective pick-up in domestic consumption stoking price pressures, patchy monsoon rains and floods in parts of India this year are likely to keep food inflation high.
There is also a possibility that imported goods could become more expensive if expectations of higher U.S. interest rates cause the rupee to weaken against the dollar.
"RBI will wait and see how data pans out post-November when base effect will wane," said Rupa Rege Nitsure, chief economist at Bank of Baroda. "My stance remains the same, that there will be a prolonged pause on rates."