High inflation may force further monetary tightening

High inflation may force further monetary tightening

KARACHI: The high inflation may force the State Bank of Pakistan (SBP) to further tighten the monetary stance as the central bank has already increased the policy rate to 15 per cent.

Analysts at KASB KTrade Securities on Monday said that the data released on August 01, 2022 shows that inflation increased by 24.9 per cent in the month of July, 16.5 per cent higher than July last year and 3.6 per cent higher than last month.

READ MORE: Pakistan inflation hits 14-year high at 25% in July

As expected, the main driver was transportation costs, which jumped by 65 per cent compared to last year. The market primarily views inflation in context of the direction of interest rates.

“Higher inflation would force the State Bank of Pakistan to further increase the rates and there could be another 200-250 basis points rate increase in his cycle.”

So far, the policy rates have been raised by 8 per cent from the trough to 15 per cent. However, real interest rates have declined to a negative 8.9 per cent which indicates that further tightening might be required to clamp down on inflationary pressures.

The real cost of inflation is on political stability, the analysts said and added that high inflation can cause a serious damage to social stability.

The most famous example of course is Germany post WW1. Even the recent Arab Spring was caused by high food inflation (bread inflation). There are many academic studies which explore the link between political instability and inflation.

READ MORE: Pakistan hikes key policy rate by 125 basis points to 15%

Some even link the demise of the Roman Empire to periods of high inflation. The two factors have a co-dependence, which makes it even more dangerous. That means, high inflation leads to political instability and political disturbance causes even more inflation. Hence the chance of a downward spiral starts to kick in.

The analysts quoted Lionel Robbins 1937 as “Hitler was the foster child of inflation”. British Economist Lionel Robbins believed that high inflation left behind a moral and economic disequilibrium which was the breeding grounds for the disaster which followed.

Inflation might be already impacting voters’ decisions in Pakistan. Ground level surveys have shown that inflation is the single most important factor which affects voters’ electoral preferences in Pakistan. This is ironic, as most governments try to follow a pro-growth strategy in the last tenure but end up causing high inflation which eventually erodes their political capital. Sugar inflation under Ayub, and the late inflationary cycle under Musharraf are some recent examples.

READ MORE: Pakistan’s sensitive price inflation surges by 37.67%

The analysts said that there is hardly any end to high inflation until oil prices come down. Exchange rate depreciation cause by the balance of payment crisis due to high oil import bill is, till now, the primary cause of inflation.

This is of course a global issue as inflation is at decade high levels across the US, the UK and Eurozone.

Our bigger fear is that if there is any disruption to food prices caused by natural disaster. Russia and Ukraine have agreed to allow the trade of grains which has led to a decline in agricultural commodity prices. However, the FAO Food Index is still near multi year high. Natural disasters such as floods or extreme temperatures could cause a supply driven spike.

Larry Fink the CEO of Blackrock recently said that he thinks the risk from food inflation is a bigger challenge than the oil price crisis. This could be a big issue and I hope Pakistan’s policymakers are planning ahead of time for it.

READ MORE: Pakistan inflation crosses 33% on high petroleum prices

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