NEW DELHI (Reuters) - Higher fuel costs drove up India's headline inflation to its highest level in five months in March, data showed, vindicating a central bank decision last week to keep its policy rate on hold amid concern about price pressures.
Consumer prices rose by an annual 3.81 percent, their fastest pace since October 2016, compared with February's 3.65 percent, the Ministry of Statistics said on Wednesday.
The rise was lower than the 3.98 percent forecast by economists in a Reuters' poll.
Retail fuel inflation accelerated to 5.56 percent from 3.90 while gains in food prices slowed to 1.93 percent from 2.01 percent.
Worries about a possible spike in food prices, should India experience below-average monsoon rains this year, persuaded the Reserve Bank of India (RBI) to keep its key lending rate on hold for a third straight meeting last week.
But in a subtle and less expected shift to a tightening bias, the central bank raised the reverse repo rate - the return banks get on deposits at the RBI - by 25 basis points, to help mop up excess liquidity in the banking system.
The monsoon season, which delivers 70 percent of India's annual rainfall, is critical for the country's rice, cane, corn, cotton and soybean crops as nearly half of its farmland lacks irrigation.
A U.S. government weather forecaster last month projected the possibility of an El Niño weather pattern developing later this year, a possibility forecasters in Japan and Australia put at 40-50 percent.
"There are reasons to think that inflation will continue to accelerate," said Shilan Shah, economist at Capital Economics consultancy in Singapore.
Such concerns prompted the RBI last week to revise up its inflation projection for the year that started in April. It now expects headline inflation to average 4.5 percent in the first half and 5.0 percent in the second, above its medium-term target.
Shah expects headline inflation to accelerate towards the upper bound of the RBI's 4-6 percent target range this year, which he said could prompt the central bank to raise its benchmark lending rate over the coming months. The bank is currently targeting the lower end of that band.
Other economists are not predicting a rate hike so soon.
While remaining committed to keeping retail inflation closer to the lower end of its target, the central bank will be hard pressed to overlook growth concerns.
In a sign that the economy is still smarting under the aftermath of Prime Minister Narendra Modi's decision in November to ban high-value currency notes, industrial output unexpectedly fell 1.2 percent in February from a year earlier.
Cost-push pressures, meanwhile, are building due to higher global commodity prices.
The rollout of a new sales tax from July also poses an upside inflation risk, as does an impending increase in house rent allowance to millions of public sector workers.
The central bank's monetary policy panel expects the latter to push up headline inflation by as much as 150 basis points over a period of 12-18 months.
"If everything becomes worse together then towards the end of the financial year 2018 there is a slight risk (of a rate hike)," said Anjali Verma, an economist with PhillipCapital India.
Reporting by Rajesh Kumar Singh; Editing by Robert Birsel and by John Stonestreet