March 07, 2022 (MLN): All eyes are on the important central bank’s monetary policy meeting tomorrow that will clarify the interest rate outlook when the country is currently encountering several economic challenges.

Apparently, the prospects of increasing interest rate hikes are relatively high to do the trick in response to soaring inflation. However, keeping in view SBP’s focus to sustain economic recovery and its last forward-looking guidance SBP may keep the policy rate unchanged at 9.75%  and may revisit its previous forward guidance as major developments have been taken place since the last MPS particularly rising commodity prices.

Inflation has remained elevated since the last MPC announcement, clocking-in at around 13% YoY in Jan’22 (highest in 24 months) and 12.24% YoY in Feb’22, respectively; mainly due to higher international commodity price index, a drastic rise in international Arab Light Oil prices which have increased by over 21% since the last MPS due to Russia-Ukraine situation, utility tariff adjustments, and hike in core inflation due to their lagged effect including withdrawal of sales tax exemptions.

In the coming months, if the government is successful in holding on to the cut in fuel and electricity prices even for the next couple of months, the same could help contain monthly inflation, albeit this would have fiscal consequences. Some pressure may be witnessed when Ramadan commences, but that has been factored into forwarding inflation expectations ever since, analyst at Taurus said.

The sharp rise in commodity prices and worries over inflation and current account outlook has resulted in an increase in secondary market yields. In the recent T-bills auction on February 23, 2022, cut-off yields have increased by 19bps, 23bps and 12bps respectively for 3M, 6M and 12M tenor.

Current Account Deficit (CAD) in Jan 2022 increased by 37% MoM to stand at $2.6bn, mainly due to 15% MoM drop in exports, 8.5% MoM rise in the trade deficit, 50% MoM and 15% MoM decline in FDI and remittances. This has induced pressure on FX reserves which plummeted by 8% MoM to $22.08bn in January’22.

Based on the above scenarios, four out of seven brokerage houses expect SBP’s monetary policy committee to increase the interest rate in tomorrow’s meeting, indicating that mixed sentiments exist among market participants. 

SBP in its last MPS stated that real interest rates on a forward-looking basis were appropriate and any changes would be relatively modest. However, the Russian-Ukraine war and its impact on global commodity prices worsened the outlook for inflation and the current account deficit in Pakistan which may force SBP to resume monetary tightening.

Moreover, SBP has hitherto guided that it will look through transitory changes in inflation and is taking cues from core inflation for MPS. But, not increasing interest rates at this stage will risk sharp PKR depreciation, which will in turn increase core inflation in due course, analyst at Intermarket Securities said.

Contrary to the above, analyst at Taurus Securities said “the decision to raise interest rate depends on what ultimate impact could a hike have on mitigating the current macroeconomic risks— not much we think.”

Albeit PM relief package would have fiscal consequences, SBP might not place too much concern over these measures and keep the policy rate unchanged in March MPS, Fahad Rauf at Ismail Iqbal Securities said.

Also, the interest rate tool would be of limited use in curbing inflation in the current scenario where the increase was mainly driven by supply-side shocks, he added.

In view of above developments, it will be interesting to see what policy stance SBP would adopt to complement the recent fiscal measures.

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