Central bank seen raising interest rate to cap soaring inflation

KARACHI: The State Bank of Pakistan is seen tightening its monetary stance at the policy meeting due next week, increasing policy rate by at least 100 basis points (bps), to cap surging consumer price inflation, analysts said on Friday.

The SBP’s Monetary Policy Committee (MPC) is due to hold a meeting and release latest statement on Tuesday, the central bank said. The central bank is slated to announce policy rate earlier than expected on July 16, one day before the market treasury bills auction will take place.

“New taxes, rupee fall and increase in gas and electricity prices will increase inflation. To fight inflation and keep the real interest rate positive the SBP may raise policy rate by 100 basis points,” Muhammad Sohail, CEO at Topline Securities, said.

Anticipating further tightening of monetary policy, another analyst said the MPS’s potential decision would be based on forward looking inflation. “The policy rate is likely to be increased to 13.25 percent (100 bps hike) this month but, the tightening cycle might end after July,” an analyst at BMA Capital said.

The SBP had raised the benchmark policy rate by 150bps to 12.25 percent in last monetary policy announced in May. Endorsing the ongoing market consensus, Abdul Rehman, an analyst at Alfalah Securities said, “We are looking at a 100 basis points increase in the policy rate”.

The central bank is using updated internal inflation forecasting models considering both core and consumer price index inflation that serve as the input to the MPC decisions. The average inflation rose to 7.34 percent in July-June 2018/19 fiscal year from 3.92 percent last year. The rupee also continues to depreciate against the dollar, declining 0.93 percent so far this week.

The International Monetary Fund (IMF), in its staff report, stated monetary policy would be focused on gradually reducing and keeping inflation low/stable. Authorities have also hinted at keeping policy rate positive in real terms, consistent with inflation.

The IMF forecasts inflation to rise to 13 percent in the current fiscal year. “The SBP will maintain an appropriately tight monetary policy to guide inflation and inflation expectations,” the report said.

“To this end, it will maintain a positive policy rate in real terms consistent with the SBP’s medium-term inflation objective and the program’s monetary aggregate targets.” Until the SBP has further advanced preparations toward an inflation targeting framework, Net Domestic Assets and Net International Reserve targets will guide money supply to rates consistent with the inflation objective of 5–7 percent, it noted.

In addition, the NIR targets will also guide the reserve accumulation under the program. However, Faizan Ahmed, head of research at Optimus Capital Management, sees no need for raising the interest rate further.

“An important point to note is that current headline CPI (Consumer Price Index) calculation methodology has measurement flaws associated with at least two items (house rent and gas prices) in the CPI basket, which are overestimating both headline and core inflation figures.”

“An overly hawkish monetary policy stance based on overestimated CPI numbers and interest rate at already high levels (an increase of 625bps since January 2018), will only swell debt servicing cost, while negatively affecting country’s equity market by discouraging risk-taking,” Ahmed added.