INEI reported that headline inflation decelerated to 0.11% m/m or 6.63% y/y and that core (ex-food) CPI declined sharply by -0.69% m/m to 3.21% y/y.  Both readings are above the central bank’s inflation target of 2% (+- 1%), but they indicate that disinflationary forces are at play.  Although the headline number was slightly higher than our expectation (0.05% m/m) and that of the Bloomberg consensus (0.09% m/m), the core reading was sharply lower than our forecast (-0.3% m/m).

Food inflation stayed elevated, driven by seasonal factors (adverse weather conditions) and a national strike, despite a sharp decline in some food prices, especially those heavily dependent on international prices of commodities.  However, inflation in transport and communications deflated rapidly on the back of declines in fuel prices (gasoline -9% y/y and petroleum -7.9% y/y) and transport tariffs, while housing , which includes fuel (kerosene -6.8% and propane gas -3.1%) and electricity, also deflated

Overall, seasonal factors and non-recurrent events (strike) negatively impacted inflation in January.  Moving forward, however, administrative measures and lower international prices of commodities will most likely continue easing inflation pressures.  Moreover, a decelerating domestic demand should keep demand pull pressures on prices at bay.  We maintain our headline inflation and core (ex-food) CPI expectations at 2.6% y/y and 1% y/y, respectively, for 2009.  In terms of monetary policy, the result bodes well with our view that the central bank will likely stay on hold at 6.5% during the February 5^th meeting (60% probability).  In 2009, we expect the central bank to start the easing cycle by March or April, and take the reference rate to 4.5% or 4% by the end of the year with most of the easing at the early stage.