The State Bank of Pakistan (SBP) on Friday kept the benchmark interest rate unchanged at 7% for the fifth consecutive time, while viewing growth and inflation expectations as well-anchored.
Encouraged by upward revision of the FY21 growth forecast to 3.94%, the Monetary Policy Committee (MPC) decided to maintain the policy rate at 7%, noting that it confirms the strength of the broad-based economic rebound since the start of the fiscal year, on the back of targeted fiscal measures and aggressive monetary stimulus.
The MPC maintained the status quo as per the market expectations of no change in the policy rate, since the SBP strongly hinted in monetary policy statements for January and March that it might maintain the rate at the current level of 7%, with the real interest rate (the benchmark interest rate minus inflation reading) hovering at negative 2%
Earlier, to support the economy from the onslaught of Covid-19 pandemic, the SBP had aggressively slashed the benchmark interest rate by 625 basis points from March to June 2020 to 7%. The policy rate was last changed in June 2020, when the MPC reduced it by 100 basis points to 7%.
In its policy statement, the SBP said that on the inflation front, the recent out-turns continue to be volatile, as inflation rose to 11.1 percent year-on year in April, propped up by the lingering impact of February’s electricity tariff increase as well as a pick-up in month-on-month food prices, partly driven by the usual seasonality around the holy month of Ramazan.
The MPC observed that although core inflation in urban areas has risen by around 1.5 percentage points during this period, available evidence suggests that demand-side pressures on inflation continue to be relatively contained. This reflects the fact that despite the economic recovery, there is still some spare capacity following last year’s contraction.
In its statement the SBP said that as previously forecast, the headline year-on-year inflation rate is likely to remain elevated in the coming months due to the recent electricity tariff hike, pushing the average for FY21 close to the upper end of the announced range of 7-9 percent. As supply shocks dissipate thereafter, inflation is expected to gradually fall toward the 5-7 percent target range over the medium-term.
The MPC noted that the current accommodative stance of monetary policy remains appropriate to ensure that the recovery becomes firmly entrenched and self-sustaining. As a result, the MPC noted that it was important for monetary policy to remain supportive.
The MPC observed that given the Covid-related uncertainties, the cost of withdrawing monetary stimulus too soon exceeded that of withdrawing too late. Taking note of the uncertainty around the inflation and growth outlook, the MPC noted that monetary policy will remain accommodative in the near term, and any adjustments in the policy rate to be measured and gradual to achieve mildly positive real interest rates over time.
Second-round effects from the supply shocks were also not visibly apparent: price pressures are concentrated in a few items, wage growth is subdued keeping a cap on costs, and inflation expectations remain reasonably anchored. As supply shocks dissipate thereafter, inflation is expected to gradually fall toward the 5-7 percent target range over the medium-term.
Since the last MPC, headline inflation has risen further, mainly driven by supply shocks to food and energy, including the lingering impact of February’s electricity tariff hikes. On a sequential basis, upward momentum in certain food prices notably fresh fruits, vegetables, dairy, poultry, and edible oil was exacerbated by the advent of Ramzan, more than offsetting the recent decline in wheat prices. “While core inflation has picked up in urban areas, price pressures were concentrated among a relatively confined set of items and spare capacity still exists in the economy. Inflation expectations also remain reasonably anchored and wage growth is still muted,” the MPC maintained. It predicted that if demand side pressures emerge as the recovery becomes more durable and the economy returns to full capacity, it would be prudent for monetary policy to begin to normalize through a gradual reduction in the degree of accommodation.
