High inflation may force further monetary tightening

High inflation may force further monetary tightening

The relentless surge in inflationary pressures may prompt the State Bank of Pakistan (SBP) to consider additional measures to tighten the monetary stance, as the central bank has already elevated the policy rate to 15 percent.

According to data released on August 01, 2022, by analysts at KASB KTrade Securities, inflation soared by a staggering 24.9 percent in the month of July. This figure represents a 16.5 percent increase compared to July of the previous year and a 3.6 percent uptick from the previous month.

The primary driver behind this inflationary surge was identified as escalating transportation costs, which experienced a significant 65 percent increase compared to the same period last year. The market, in response, is closely monitoring inflation trends in conjunction with the direction of interest rates.

Analysts predict that higher inflation may necessitate the State Bank of Pakistan to further raise interest rates, potentially leading to another 200-250 basis points increase in this cycle. So far, policy rates have already witnessed an 8 percent increment from their trough to the current 15 percent. However, real interest rates have dipped to a negative 8.9 percent, signaling the potential need for further tightening to mitigate inflationary pressures.

Beyond economic concerns, analysts emphasize the broader impact of inflation on political stability. High inflation has the potential to inflict serious damage on social stability, as historical examples demonstrate. Instances like Germany post World War I and the Arab Spring, triggered by high food inflation, underscore the correlation between political instability and rising prices.

Drawing parallels with history, analysts quoted economist Lionel Robbins’ 1937 assertion that “Hitler was the foster child of inflation.” Robbins believed that high inflation created moral and economic disequilibrium, paving the way for subsequent disasters.

In Pakistan, ground-level surveys indicate that inflation plays a pivotal role in influencing voters’ decisions. It stands as the single most crucial factor affecting electoral preferences. Ironically, governments often pursue pro-growth strategies in their last tenure, inadvertently causing inflation that erodes their political capital. Past instances, such as sugar inflation under Ayub and the late inflationary cycle under Musharraf, serve as recent examples.

Analysts highlight that high inflation might persist until oil prices experience a significant downturn. Exchange rate depreciation, driven by a balance of payment crisis stemming from a high oil import bill, remains the primary cause of inflation.

This global issue extends beyond Pakistan, with inflation reaching decade-high levels in the US, the UK, and the Eurozone. The concern intensifies as global food prices remain elevated, with the FAO Food Index hovering near multi-year highs. While Russia and Ukraine have allowed grain trade, potential disruptions due to natural disasters like floods or extreme temperatures could lead to a supply-driven spike.

Larry Fink, the CEO of BlackRock, recently voiced concerns, stating that the risk from food inflation is a more significant challenge than the oil price crisis. As the world grapples with inflationary pressures, there is an increasing need for strategic planning by policymakers to navigate potential challenges on the horizon.