State Bank raises policy rate by 100bps to 16pc to curb inflation

The State Bank of Pakistan announced on Friday that it had increased the interest rate by 100 basis points (bps) to 16 per cent to curb inflation. The announcement came after a meeting of the bank's Monetary Policy Committee (MPC).

The central bank said that the decision was aimed at ensuring that "elevated inflation does not become entrenched and that risks to financial stability are contained, thus paving the way for higher growth on a more sustainable basis".

The SBP identified higher food and core inflation as "key contributors" to elevated inflation. The bank maintained growth projections for the financial year 2023 and the current account deficit (CAD) the same as the last policy statement at 2pc and 3pc of GDP, respectively.

According to the SBP press release, the decision to raise the policy rate reflected the MPC's view that "inflationary pressures have proven to be stronger and more persistent than expected".

The MPC noted that amid the ongoing economic slowdown, inflation was "increasingly being driven" by persistent global and domestic supply shocks that were raising costs. "In turn, these shocks are spilling over into broader prices and wages, which could de-anchor inflation expectations and undermine medium-term growth.

As a result, the rise in cost-push inflation cannot be overlooked and necessitates a monetary policy response. "The MPC noted that the short-term costs of bringing inflation down are lower than the long-term costs of allowing it to become entrenched. At the same time, curbing food inflation through administrative measures to resolve supply-chain bottlenecks and any necessary imports remains a high priority," the press release reads. The press release added that since its last meeting, the MPC had noted three key domestic developments.

Firstly, it said that headline inflation increased "sharply" in October, as the previous month's administrative cut to electricity prices was unwound, food prices also "accelerated significantly" due to crop damage from the recent floods and core inflation rose further. Secondly, the MPC pointed out that a sharp decline in imports led to a "significant moderation" in the current account deficit in both September and October. However, it added that external account challenges persist despite this moderation and fresh funding from the Asian Development Bank. Thirdly, it said that while growth and CAD projections were reaffirmed at 2pc and 3pc, average inflation for FY23 was projected at 21-23pc due to higher food prices and core inflation.

Regarding the overall inflation outlook, the MPC said that while inflation was likely to be more persistent than previously anticipated, it was "still expected to fall toward the upper range of the 5-7pc mediumterm target by the end of FY24" due to support from "prudent macroeconomic policies, orderly rupee movement, normalising global commodity prices and beneficial base effects". "The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth," the press release added.

The central bank's decision was unexpected as a number of analysts and economists said it was expected to keep the main policy rate unchanged at 15pc in its monetary policy announcement.