SBP may continue with monetary policy tightening; 100 basis points increase likely

KARACHI: The State Bank of Pakistan (SBP) likely to increase key policy rate by 100 basis points in the next monetary policy announcement scheduled for May 20, 2019, analysts said.

Analysts at Arif Habib Limited forecast another rate hike of 100bps in policy rate from 10.75 percent to 11.75 percent in the upcoming monetary policy.

The aggressive monetary tightening is expected to continue by the central bank as it is going to be the seventh consecutive rate hike, they said.

The monetary tightening is expected on the back of

i) rising inflationary pressure due to rise in prices of petroleum products and essential food items coupled with continuous slide of PKR leading to surge in prices of imported and local products (sold on import parity),

ii) mounting Fiscal Deficit despite sharp cut in PSDP and rationalization of tariffs and duties, and

iii) narrowing real interest rate as it declined to 1.66% in May’19 compared to last four year average of 2.75%.

The analysts believed the SBP is adopting a proactive stance to increase policy rate on account of higher inflation in upcoming months alongside attempting to curtail the current account deficit.

Since October 2011, the analysts observed that during International Monetary Fund (IMF) period real interest rate (RIR) has always remained on the higher side at an average of 3.1 percent compared to an average of 2.2 percent in non-IMF period.

“This depicts that the IMF expects an increase in discount rate for sustainability despite lesser CPI during the period,” they added.

Furthermore, it seems like the money market has already incorporated the rate hike which is essential to fulfill the gap of 61bps between 12-M T-Bills (11.86 percent) and Discount Rate (11.25 percent).

The analysts conducted a short survey with institutional investors regarding their view on 1) interest rate in the upcoming Monetary Policy Statement (MPS) and 2) outlook on interest rates going forward.

Majority of the respondents (53 percent) are of the view that the interest rates are likely to see a 100 bps spike in the upcoming MPS.

Only 12 percent of the respondents opined that the rates may see a 150 bps surge.

With regards to whether interest rates have peaked, 71 percent of the respondents are of the view that the rate hike era is yet to halt and will see further hikes going forward.

It is asked the poll respondents about their 1-Yr forward view on the interest rate cycle. About 48 percent of the respondents are of the view that interest rates will see a surge of 50-100 bps in the next one year.

Around 29 percent of the respondents do not see any further rate hike following the upcoming MPS.

The analysts believed that May 2019 inflation to settle at 9.59 percent YoY compared to 4.19 percent in May 2018 and 8.82 percent in April 2019, respectively.

They said inflation to continue its upward trajectory in upcoming months amid low base effect of last year, sharp increase in prices of perishable goods (fresh vegetables and fresh fruits), lagged impact of adverse exchange rate movements and gradually increasing international oil prices which may result in higher prices of local petroleum products (MoGas and HSD). This may keep inflation in the range of 9.0-9.5 percent for the next four months.

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