The government move to allow diesel price hikes is likely to add 120 basis points to inflation, which is expected to be in the 7-7.5 per cent range in the March quarter, a Bank of America Merrill Lynch report said.
"Inflation will follow an inverted U curve in FY'14," BoA-ML India Economist Indranil Sen Gupta said in a report adding that "last evening's diesel price hikes that will add 120 basis points (1.2 per cent) to FY'14 inflation."
In bold reforms, the government yesterday moved towards deregulating diesel rates when it raised prices by 50 paisa per litre and planned similar monthly hikes in future to cut record subsidies.
According to the report, inflation would persist around 7 per cent in the March quarter, then likely go back up to 7.5-8 per cent in the second half of 2013. It would then abate to 6.5-7 per cent by March 2014.
Against this backdrop, the Reserve Bank is likely to cut policy rates by 25 basis points on January 29, it said.
The report further noted that RBI is likely to cut rates by 75 basis points by June, pause in 2nd Half of 2013 as inflation picks up and cut 50 basis points again in the March 2014 quarter as inflation subsides.
Some of the major factors that can influence Inflation in India include Delhi's political ability to hike diesel prices, oil prices and monsoons, it added.
Meanwhile, notwithstanding expectations of interest rate cut by RBI in its quarterly monetary policy on January 29, RBI Governor D Subbarao has said that "Inflation has come down, (but it is) still high".
Although inflation based on movement in wholesale prices, touched 3-year low of 7.18 per cent in December, retail inflation continued to be in double digit at 10.56 per cent.
Although WPI-based inflation has witnessed a decline in the last few months but at 7.18 per cent it is still much above the central bank's comfort level of 4-5 per cent.
The inflation has not declined to the expected levels despite tight monetary stance pursued by the RBI to check the rate of price rise.