SBP likely to raise rates to cap inflation, manage CAD

State Bank of Pakistan’s Monetary Policy Committee will announce Monetary Policy later in the day today as it seeks to cap the rising inflation, widening current account deficit and maintain real interest rate differentials with other major economies.

During the last meeting held in March, 2018 the MPC had decided that, “following detailed deliberations, the Monetary Policy Committee is of the view that some time may be allowed for the impact of recent policy developments to unfold and has therefore decided to maintain policy rate at 6.0 percent for the next two months.”

The market has expected the State Bank to raise rates during its March meeting but Committee (MPC) had opted to allow some time for key policy measures i.e. exchange rate flexibility, allowing the export package to yield benefits, and imposition of new regulatory duties on the current account imbalances. However, despite numerous signs posts indicating an incumbent hike i.e. rising global crude oil prices, current account imbalances, increasing inflation were all ignored in the previous meeting as MPC was looking for policy measures to address these issues on their own in the market.

This time around, the case for rising rates is even stronger, some of the key economic indicators underpinning the monetary policy decision have been mounting over the period of last two months. The street expects SBP to raise interest rates by somewhere between 25 bps to 50 bps during today’s announcement owing to negative real interest over core non-food, non-energy (NFNE), increasing Current Account deficit and to maintain real interest differentials in congruity with other major economies. The case for hike has been further reflected by the 28bps/48bps increase (since the end of January 2018) in 12-month KIBOR/12-month T-bills yields to 6.52%/6.78%.

In addition to that, the government’s to do list for the month of May also includes a 10 Year Floating Rate PIB on May 31^st 2018. The bond auction is to be based on the 6-month cut off yield as per the last auction of T-bills. But keeping in view that SBP received no bids in 24^th May auction – the reference point – SBP will may resort to other options. Since, SBP does decide to raise rates in today’s announcement, 6-month cut off yields for 10^th May, 2018 will also have to be ignored. The government may resort to the 6-month PKRV rates as a reference point. Currently the six-month PKRV rate is at 6.45 percent which if the bank raises rates will jump to 6.70 percent in the coming week.

Coupled with this are the rising global oil prices which have gone to reach $80 a barrel. Oil imports have a major impact on Pakistan’s overall trade imbalance. The country has been suffering long due to its rising imports as a result of increasing local demand. Oil prices have become a major cause of concern for governments, as the rise in per barrel prices have increased retail prices in the world fueling a global rise in inflation. India, and U.S. have increased local retail oil prices to three year highs as OPEC led cuts begin to bear fruits for the oil producing nations. Therefore, the key themes influencing the MPC decision today include the rising headline inflation as the market expects CPI inflation to increase to 4.0 – 4.5 percent year on year in May, 2018 from 3.7 percent in April, 2018 owing to the rise in food inflation during Ramzan.

In a survey conducted by MG Link News involving 24 brokerage and research houses, the average market expectation for the rate hike is at 6.25 percent. Of all the participants i.e. brokerage houses, research, and investment companies in the survey, five estimate the SBP to keep rates unchanged at 6.00 percent, 10 anticipate a 25bps raise whereas nine expect State Bank to take a proactive approach and raise rates by 50bps in today’s announcement.