July 6, 2022 (MLN): Pakistan’s central bank is scheduled to meet on Thursday 7th July 2022, to determine the benchmark interest rate for the next six weeks.

This time, market participants seem to be somewhat divided over whether SBP will go for further monetary tightening or keep the policy rate unchanged at 13.75%.

With inflation reaching a 13-year high (21.3% YoY), most analysts believe that monetary settings need to be levelled up by 100 bps or above with the recent shift in fiscal settings to arrest rising inflation and manage the exchange rate and current account deficit.

“We expect SBP to increase the policy rate by 100bps to 14.75% in the upcoming monetary policy. Since the last monetary policy meeting risks to external stability remained elevated and the outlook for inflation deteriorated led by domestic and international factors. Therefore, this policy response is expected to help moderate demand”, Tahir Abbas at Arif Habib Securities said.

In addition to a policy rate hike, the MPC might also increase the interest rate on the export finance scheme (EFS) and long-term financing facility (LTFF) loans, he added.

Similarly, Saad Hashemy, Executive Director BMA Capital Management while speaking to MG News said, “SBP will continue monetary tightening tomorrow due to the high inflationary environment and also the continued high trade and current account deficit. Further, it is likely that the rates have peaked for now and further direction will be determined by international energy prices and also the PKR.”

In contrast, some market participants are of the view that inflation is cost-push and an interest rate hike would not help in bringing down inflation. Also, Pakistan’s monetary and fiscal policies are currently in the contractionary mode and most of the tightening has already been done in the form of various fiscal measures taken by the government as well as a hike in the policy rate by 400bps so far this year to curb demand and anchor inflation. Further rise in interest rate will not have much impact on demand but will hurt economic growth and increase debt servicing costs.

“The market has incorporated a 100bps increase, which is evident from the secondary market yields of government securities. In my view, there is no need to increase interest rates” Fahad Rauf Head of Research at Ismail Iqbal Securities told MG News.

The economy is already slowing down. The layoffs have started and are expected to increase further. Further cost pressures would only enhance the burden on industries and workers, he said, adding that tough fiscal measures have already been taken, hence SBP needs to wait for the results before further tightening.

Now, if we look at the shape of the yield curve to infer the market expectations for monetary policy, we see a jump in the yields since the last monetary policy in May’22. On the PKRV front, 3M, 6M, 9M and 12M tenors have increased within the range of 60bps-83bps respectively as of yesterday. Currently, 3M, 6M, 9M and 12M PKRV hovering at 15.1%, 15.23%, 15.34%, and 15.48% respectively. On the KIBOR side, 3M, 6M, 9M and 1Y tenors have increased within the range of 58 bps-73bps since the last MPS.

Furthermore, in the latest T-bills auction on June 29, the cut-off yields for 3M, 6M and 12M were 15.23%, 14.80% and 14.95%, respectively – averaging a spread of around 100-150bps. Rate hike expectations further stem from the latest OMO on Tuesday, where SBP injected liquidity at a higher interest rate into commercial banks, signalling it would increase its key policy rate in the upcoming MPC meeting.

Inflation, CAD at alarming levels

To recall, in the previous MPC meeting held on May 23, the SBP raised the policy rate by 150 basis points to 13.75% aimed at containing the rising inflation and mitigating the risks to external stability. Despite the rise in interest rate, M2 growth swelled to Rs26.8 trillion as of June 24, 2022, mainly due to high budgetary borrowings of Rs18trn, up by 5% from May’22 MPS.

Headline inflation for Jun’22 soared to alarming levels of 21.3%YoY, well above market expectations. On the external front, the turbulence continues as the current account deficit during 11MFY22 increased massively to $15.2bn compared with a deficit of $1.2bn during the same period last year. Another major concern on the external front remains the SBP reserve position which stands at $10.3bn as of 24th Jun’22, resulting in depreciation of PKR by 15.14% against the greenback from CY22 to date.

In the coming months, the headline inflation will remain on the higher side on account of the continued increase in fuel, electricity and food prices. This coupled with the super cycle of international commodity prices owing to geopolitical tension and supply bottlenecks will remain the major challenge for inflation.

Based on the above-discussed scenarios, most of the market participants believe that hike in policy rate is inexorable. In a survey conducted by MG News, 12 out of 14 brokerage houses expect a rate hike in tomorrow’s MPC meeting, of which five expected a hike in the range of 100-150 bps while seven brokerage houses predicted a rate hike ranging from 50-100 bps. Meanwhile, two were of the view that SBP will keep the policy rate unchanged at 13.75%.

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