For the first time in months the prospects of an interest rate cut by the Reserve Bank of India when its officials meet next week looks a probability.

Inflation has fallen sharply in the last few weeks with CPI and WPI inflation showing a sharp deceleration.
October WPI Inflation fell to a 5-year low of just 1.77 per cent, while CPI Inflation dropped to 5.52 per cent for the month of October. This was the lowest level that CPI has fallen since the country started computing Consumer Price Index (CPI) in January 2012. One of the major cues for the RBI when deciding on interest rates is inflation, which for the moment seems to have been tamed.

Falling Crude Prices is Good News to the RBI's ears

Until early this week, not many analysts were optimistic of an interest rate cut. But, Crude Prices have fallen sharply in the last few days, raising the prospects of an interest rate cut. In fact, Brent Crude has fallen to the near $72 a barrel, something that we could not think of a month back.

Clearly, the trajectory of inflation is lower. There's a greater probability that inflation would stay low in the coming months which might force the RBI to cut interest rates after several months.

Another key figure that the RBI would also watch is the GDP numbers. India's GDP numbers came for Q2 2014 came in at 5.35 per cent.

The RBI has to do a balancing act when it comes to inflation and interest rates. Here is where it faces a tricky situation. While inflation has been trending lower, the problem is that this economic indicator can rear its head anytime if things go awry.

Should crude prices climb due to geo-political turmoil or for any other reason we could see inflation rear its head again. The RBI has to therefore take a very calculated decision before cutting interest rates.

Banking stocks on Friday rallied sharply on hopes that the RBI would cut interest rates. At the moment one would not like to bet against an interest rate cut at this stage.

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