Monetary Policy Outlook September-2023: 150bps increase expected

September 13, 2023

The upcoming meeting of the Monetary Policy Committee (MPC) is scheduled for September 14th, where the benchmark interest rate will be determined. Currently, the policy rate stands at a historic high of 22%. In the last MPC meeting, the State Bank of Pakistan (SBP) opted to keep the rate unchanged. However, there is growing market anticipation of a potential increase in the policy rate, ranging between 100 to 200 basis points (bps). This expectation of a rate hike is primarily fueled by the persistence of high inflation levels, which have not subsided as expected in the second half of 2023. It is expected to further rise owing to Fuel and electricity price adjustments.

Several factors contribute to this ongoing inflation, including the absence of administrative control over the prices of essential food items and increases in energy tariffs due to the devaluation of the PKR and structural inefficiencies. In Pakistan, inflation is predominantly influenced by supply-side factors, exacerbated by abrupt currency depreciation. Additionally, a policy rate increase would raise the federal government’s debt servicing costs, a significant concern given the limited fiscal space. For FY24, the projected debt servicing cost is approximately PKR 7.3 trillion, compared to projected revenue of approximately ~PKR 9.4 trillion.

Recent T-bills auctions indicate that banks are preparing for a potential rate hike of 150 to 200 bps. Yields for 3-month and 12-month bills have risen by approximately 162 bps and 213 bps, respectively, with cut-off yields for 3-month, 6-month, and 12-month papers at approximately 24.49%, 24.78%, and 25.06%, respectively.

Regarding inflation, it is expected that the headline Consumer Price Index (CPI) will peak in September 2023 between 30% to 32%. This surge is attributed to rising food and petroleum product prices. In the coming months, inflation is anticipated to remain at elevated levels, primarily influenced by adjustments in energy tariffs and the low base formed in September 2022 due to electricity tariff adjustments. Headline inflation is projected to average around 28%% until December 2023, with an average inflation rate of ~24% for FY24, without factoring in the potential impact of an awaited gas price hike. Hence, SBP is expected to target FY24 Average inflation rate in MPC.

It’s important to note that core inflation during August 2023 stood at approximately 25.9% and 18.4% in rural and urban baskets, respectively. Given these factors, it is anticipated that the SBP will likely raise the policy rate by approximately 150 bps in the upcoming MPC meeting to achieve a real positive interest rate.