CPI Review: Could SBP bring even more rate cuts?

May 04, 2020 (MLN): In line with the market consensus, the headline inflation in Pakistan finally fell into single-digit level to 8.5% in April 2020 after a hiatus of 8 months.

To recall, in March 2020 Consumer price inflation was 10.24%, depicting a decline of 0.8% MoM.

In 10MFY20, the headline inflation averaged at 11.24% compared to 6.52% in the corresponding period last year. This was largely in line with SBP’s forecast of 11-12% CPI in FY20, suggesting that the inflation is no more concern now and it is expected to ease further in the months ahead on the back of recent reduction in fuel prices and muted demand due to Covid-19 pandemic.

The major contributor in easing CPI for April 2020 was the food index (constitutes 34.58% weight in CPI) which fell to 11.4% YoY during the month compared to 14% in March 2020. Within the food group, the subsiding food prices of basket heavy items such as wheat & wheat products, milk & related products, chicken, cooking oil/ghee and vegetables contributed heavily to large MoM reduction in the month under review.

Apart from Food inflation, Housing rent, Water, Electricity, Gas & other group which weighs 23.6% in CPI basket and Transportation group which weighs 6% also helped in suppressing April’20 CPI numbers as the former deflated -0.3% MoM, mainly due to -16.5% reduction in prices of Liquefied Hydrocarbons (Kerosene oil) and the latter declined – 4.5% MoM, supported mainly by -9.1% reduction in prices of motor fuel.

Undoubtedly, a large reduction in April’20 CPI numbers was foreseeable as the countrywide lockdown during the month kept more than 30% of the CPI basket completely unchanged. Majority of these unchanged items were Non-Food-Non-Energy (NFNE) in nature, which were directly affected by continuing lockdown, a report by BMA Capital stated.

Furthermore, this is also evident in core inflation, which slowed to a two-year low of 6.4% Y-o-Y in April.

Going forward, keeping the current inflation trajectory into consideration, and if the lockdown period extends, SBP may lower policy rate by further 100-150 bps in the upcoming MPC meeting in addition to 425 bps cut on the prospects of a further slowdown in inflationary pressure due to weak energy and food prices amid lockdown. Moreover, the impact of rupee appreciation against greenback would further support shrinking inflation.

On the other hand, Treasury yields on the short end dropped to as low as 7.3% by end April and as low as 8.5% for the three-year bond. This clearly points to market expectations of at least another cut given that the policy rate currently stands at 9%, another report by EFG Hermes highlighted.

However, the report argued that the additional rate cut before June might not necessarily be the best move in the medium term because of the two important factors. First, the real rates are conditional on a very favourable inflation outlook, which might change over the coming few months.

Second, the SBP has already put in place a number of subsidised lending schemes, providing favourable lending rates to various sectors in the economy. The report cautioned that too much of easing; which though warranted in the very short-term given the ramifications from COVID-19 to the economy, but eventually some of this easing would have to be reversed over the next year when inflation returns to more normal levels and when fiscal reforms will likely resume.

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Posted on: 2020-05-04T15:46:00+05:00