Short-term yields rise on rate hike expectations

KARACHI: Short-term market treasury bill yields increased at a latest auction, as investors expect the central bank will hike interest rates at its upcoming policy review due next week.

The International Monetary Fund has advised Pakistan to continue the cycle of monetary tightening in order to control inflation, which has convinced investors that rates will be raised at the upcoming policy meeting on July 31. However, it would be a difficult decision as inflation has eased in recent times, according to analysts.

The cut-off yield on the three-month T-bill rose by 18 basis points (bps) to 22.9788 percent. The yield on the six-month paper was down by 4 bps at 22.9201 percent. The yield on a 12-month paper inched up by 1 bps to 22.9991 percent, according to data from the State Bank of Pakistan (SBP) released late Monday.

Against a target of Rs900 billion, the government raised Rs621 billion through the sale of T-bills. “Despite the upcoming monetary policy announcement, there was robust participation in the T-bill auction, driven by market concerns of a potential rate hike. Interestingly, the government borrowed less amount than target, signaling its reluctance to borrow at higher interest rates. Investors are eagerly awaiting the monetary policy statement on July 31, 2023, which is expected to bring clarity to the interest rate outlook for the next two months, guiding market participants to make appropriate decisions,” said Chase Securities in a note.

The market has mixed opinions on upcoming monetary policy, according to Fahad Rauf, head of research at Ismail Iqbal Securities. “At current rates, not more than a 50 bps hike is incorporated. I expect a 100bps hike, given IMF's strict stance around tight monetary policy,” Rauf said.

Less than two weeks before the next policy meeting of Pakistan's central bank, the IMF stated in a staff report on July 18 that the country must maintain its cycle of monetary tightening. The statement came one week after the lender approved a new bailout deal for the country.

On June 26, the SBP held an emergency meeting and hiked the policy rate by 100 basis points to a record 22 percent. The necessity to establish a positive real interest rate and act as an anchor for managing and taming inflation expectations was taken into consideration when the decision was made.

“Although the latest policy rate move from the SBP is a welcome step, the authorities have generally been sanguine about inflationary pressures quickly receding and returning to their 5–7 percent inflation target range by end-FY25,” IMF said in its report.

“Staff emphasised that the SBP will need to continue its tightening cycle to re-anchor expectations given that inflationary pressures are expected to persist over the coming year, including because the impact of exchange rate corrections will continue to reverberate through the economy,” it added.

The Karachi-based brokerage house Arif Habib Limited expects the headline inflation for FY2024 will come in at roughly 20.8 percent, which is less than the IMF's projection of 25.9 percent. Notably, real interest rates have already started to move in the right direction in light of these expectations. However, some market investors now expect the likelihood of a further increase in interest rates in the upcoming monetary policy meeting in light of the higher inflation forecasts provided by the IMF.

As stipulated in the stand-by arrangement with the IMF, the government raises electricity rates for commercial and residential consumers. Analysts estimate that the increase in electricity rates will directly affect inflation as measured by the consumer price index (CPI), but that there will also be a second-round effect in the coming months.

The CPI Inflation to 29.4 percent in June decreased from 38 percent in the previous month. According to data released by the State Bank on Tuesday, the government's borrowing from banks to cover the budget deficit increased 218 percent to Rs499.46 billion in the first two weeks of this fiscal year.

However, the private sector paid back Rs170 billion to the banks between July 1 and July 14, 2023, compared to Rs 27.1 billion during the same period a year earlier.