SBP likely to hold key rate steady as IMF warns of inflationary risks

KARACHI: The State Bank of Pakistan (SBP) is expected to leave its benchmark interest rate unchanged at 22 percent on January 29, given the possibility of continued high inflation brought on by rising energy prices.

Most analysts The News spoke to said that the SBP would wait to see how the elections, which are set for February 8, play out as well as the immediate consequences of rising gas and electricity tariffs and their knock-on effects.

Nonetheless, considering that real interest rates are positive on a forward-looking basis, some analysts still predict at least a 50 basis point decline in the policy rate next week.

The cut-off yields on local currency bonds and lending rates fell significantly at the last few auctions, despite December's elevated inflation, indicating that the money markets priced in an early rate cut, most likely in the January policy review meeting. The likelihood of a decline in inflationary pressures due to an Rs8 decrease in local fuel prices compelled the markets to wager on an early monetary easing.

However, both the markets and analysts are debating when to expect the first rate cut in more than three years in response to the revelations of the latest report from the International Monetary Fund.

"We expect interest rates to remain unchanged due to higher inflation trajectory and external imbalances," said Awais Ashraf, director of research at Akseer Research.

"A probable increase in energy prices to stop the accumulation of Circular debt, imposition of taxes to cover revenue shortfall, limited space for subsidies and a spike in commodity prices due to political tensions would pose an upside risk to inflation at this moment," Ashraf added.

The IMF stated in its country report, which was released last week after it finished the first review of a $3 billion bailout package for Pakistan, that the SBP's Monetary Policy (MPC) has kept the policy rate at 22 percent since late June 2023, taking into account that easing supply constraints, restrictive fiscal policy, and weak demand (reflected in negative private credit growth and a sharp slowing of reserve money) would place downward pressure on inflation in the second half of fiscal year 2024.

"Given elevated near-term inflationary risks, monetary policy needs to remain tight and proactive to guide inflation back to target," the IMF said.

"Although the forward-looking real policy rate has returned to positive territory, there is no room for complacency given near-term risks. With inflation expectations still not firmly anchored, utmost caution is warranted and the MPC should respond forcefully and without delay if inflationary pressures reemerge," it added.

A tight monetary stance is critical to reduce inflation, re-anchor expectations, and support external sector rebalancing through the exchange rate, according to the IMF.

Last week, Pakistan got a $700 million second tranche from the IMF's $3 billion loan programme and the United Arab Emirates rolled over an existing $2 billion loan for one year.

Pakistan's headline consumer price index (CPI) inflation is projected to remain above 20 percent through the fourth quarter of FY24.

The CPI for December rose 29.7 percent from a year ago.

The IMF projects 18.5 percent inflation in FY24. The SBP expects inflation to decline to 20-22 percent in FY24 from 29.2 percent in FY23.

"Though inflation is coming down, the pace of that is slower than expectations. That's why we don't think rates will come down in January. Maybe in the next meeting," said Topline Securities Limited CEO Mohammed Sohail.

The next monetary policy meeting will be held in March, according to the SBP's monetary policy calendar. Analysts expect a 700 basis points cut in the policy rate in 2024, reaching 15 percent by December 2024.