SBP may cut policy rate by 50bps

KARACHI – The continuous declining trend of Consumer Price Index (CPI) settling to 1.7%, coupled with 5.3% real interest rates, have given an ample room to the central bank for slashing its target rate by 50 basis points (bps).

The central bank is scheduled to announce its monetary policy today, which would consider better economic indicators and declining yields of bonds, hinting on a possible policy rate cut of 50bps. The possibility of maintaining the rate at its current level is less but cannot be ruled out completely, as any cut would also put further pressure on banking margins.

On a conservative note, average CPI in the first half of 2016 was projected to stand at 2.5% as against policy rate of 6.5%, implying a huge real interest spread of 400bps. Core inflation (Core NFNE) settled at 4% year-on-year (YoY) during August 2015.

The reason of sustainable downward trend of headline inflation was mainly due to lower prices of petroleum products in the international and local market, which was further supported by controlled food prices in the domestic market. Other commodity prices such as coal and cotton have also decreased on YoY basis.

Similarly, yields in recent Pakistan Investment Bonds’ auction also declined by on average 16.3bps, suggesting the market stance over a possible rate cut.

The improvement in balance of payment has been observed while surge in foreign exchange reserves stands at an impressive level of $18.6 billion. These reserves are expected to ascend due to $20 billion target for SBP reserves set by International Monetary Fund (IMF) by FY16.

In the previous monetary policy, SBP highlighted the room for a rate cut but remained cautious over the post flood impact on the local commodities’ prices. However, lower CPI for August would give reason to make decision of rate cut.

The analysts have said that the SBP should downward adjust the long term lending rates to promote capital investment and boost the investors’ confidence to spur private sector growth and achieve a GDP target of 7% till FY18.

Though recent hike in gas prices and the fertilisers companies’ decision to increase urea prices would accelerate food inflation but it is unlikely to overshadow the indicators considered for policy cut.

It is expected that inflation would continue its existing downward trajectory and low international oil prices would also act as a catalyst for low inflation.

The expected foreign inflows on account of Extended Financing Facility (EFF) from IMF are anticipated to support the balance of payment situation of the country going forward. Increasing workers’ remittances are also supporting the current account deficit.In the last monetary policy, the central bank maintained the policy rate unchanged at 6.5%.

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