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NEW DELHI (Reuters) - India's retail inflation cooled to a two-year low in November after Prime Minister Narendra Modi's shock currency replacement programme dented consumer spending, fuelling hopes of an interest rate cut by the RBI at its next policy review.
Consumer prices rose by an annual 3.63 percent last month, their slowest pace since November 2014, government data showed on Tuesday. Economists surveyed by Reuters had expected prices to rise 3.90 percent year-on-year, compared with a 4.20 gain in October.
Food inflation was 2.11 percent last month, lower than October's 3.32 percent.
Modi's sudden move on November 8 to cancel 500-rupee and 1,000-rupee banknotes, which accounted for 86 percent of the cash circulating in Asia's third-largest economy, has disrupted daily life, depressing consumer demand.
People struggling to get new notes are holding back on spending, except for immediate and urgent needs.
November's reading is way below the Reserve Bank of India's (RBI) 5 percent inflation target for March 2017 as well as the medium-term target of 4 percent.
With the cash shortage hitting consumer demand, some economists expect headline retail inflation to stay below 4 percent in coming months and undershoot the RBI's March target by at least 50 basis points.
"I expect the demonetisation impact to help cool off inflation till February, due to demand contraction," said Rupa Rege Nitsure, chief economist at L&T Finance Holdings in Mumbai.
"I expect RBI to cut rates in February."
In a sign of things to come, Indian services activity plunged into contraction in November for the first time since June 2015, due to a sharp decline in demand, a survey showed, while factory activity also slowed.
Still, the RBI surprised investors last week by keeping interest rates on hold, saying the impact of the currency swap programme on the economy would be transitory.
The central bank also flagged inflationary risks emanating from the currency shortages that could endanger the winter crop, and an uncertain outlook for global crude prices and increasing volatility in the foreign exchange market.
Crude oil prices this week hit their highest level since mid-2015, after the world's top crude producers agreed to the first joint output cut since 2001.
The U.S. dollar's rally against emerging market currencies, such as the rupee, on bets that Donald Trump will adopt policies to spark growth, has also raised the spectre of imported inflation.
"There is limited scope for deeper easing," said Abhishek Upadhyay, an economist at ICICI Securities Primary Dealership.
Editing by Clarence Fernandez