India's headline inflation picked up in February on higher fuel costs but another measure of price pressures cooled, reinforcing expectations that the central bank will deliver a rate cut next week.
The wholesale price index (WPI), the main inflation indicator, rose an annual 6.84 percent in February, higher than the 6.54 percent rise estimated by analysts. Wholesale prices rose 6.62 percent in January.
But non-food manufacturing inflation, which the central bank uses to gauge demand-driven price pressures, slowed to 3.8 percent in February from 4.1 percent a month ago.
"Though the headline number is still high, the break-up (detail) shows that inflation will continue to ease going ahead and along with the government's fiscal consolidation efforts, there is even more reason to expect RBI to cut rates in March and for some more time going ahead," said Rahul Bajoria, regional economist at Barclays Capital.
The annual reading for December was revised up to 7.31 percent from 7.18 percent, the government said in a release on Thursday.
The benchmark 10-year bond yield fell 4 basis points to 7.86 percent after non-food manufacturing inflation for February came well below expectations, raising hopes the central bank would cut interest rates next week.
Expectations of a rate cut at the Reserve Bank of India's policy review on March 19 were further bolstered by Governor Duvvuri Subbarao's comments overnight that the 2013-14 federal budget unveiled last month will have a "softening impact" on price growth.
Bond traders read Subbarao's comments as an endorsement of the government's efforts to reduce its fiscal deficit, which he has previously said is a necessary condition to bring down borrowing costs.
The central bank, which has faced intense pressure from industry and government to loosen monetary conditions to help arrest the worst economic slowdown in a decade, cut its key lending rate by 25 basis points to 7.75 percent in January after leaving rates on hold for nine months.
While the bank is widely expected to cut the interest rate by another 25 basis points at its upcoming policy review on March 19, inflationary risks stemming from high food prices have tempered expectations for any aggressive monetary easing.
(Read More: India Central Bank Hawkish Despite Easing Inflation)
Higher prices of food items pushed up consumer price inflation to 10.91 percent in February from 10.79 percent a month ago, government data on Tuesday showed.
Slowing economic growth is equally a major worry for the Congress-led coalition government as it gears up for a general election due by May 2014.
Not only is the slowdown limiting employment opportunities for India's burgeoning population, it is also making it tougher for Prime Minister Manmohan Singh to fund his flagship welfare programs.
Gross domestic product increased 4.5 percent in the quarter to end-December and is on track to post its slowest gain in a decade at around 5 percent for the fiscal year that ends in March.