Governor SBP said, recent out-turns are also encouraging, suggesting a waning of supply-side price pressures from food and still-benign core inflation
KARACHI: The Monetary Policy Committee (MPC), in a meeting held on Friday, decided to maintain the policy rate at 7 percent. The MPC noted that since the last meeting in November, the domestic recovery has gained some further traction.
Most economic activity data and indicators of consumer and business sentiment have shown continued improvement. As a result, there are upside risks to the current growth projection of slightly above 2 percent in fiscal year 2020-21.
On the inflation front, the governor SBP said, recent out-turns are also encouraging, suggesting a waning of supply-side price pressures from food and still-benign core inflation. While utility tariff increases may cause an uptick in inflation, this is likely to be transient given excess capacity in the economy and well-anchored inflation expectations, he added.
As a result, inflation is still expected to fall within the previously announced range of 7-9 percent for 2020-21 and trend toward the 5-7 percent target range over the medium-term. With the inflation outlook relatively benign aside from the possibility of temporary supply-side shocks, the MPC felt that the existing accommodative stance of monetary policy remained appropriate to support the nascent recovery while keeping inflation expectations well-anchored and maintaining financial stability.
While noting these favorable growth and inflation developments, the MPC also stressed that considerable uncertainty remains around the outlook. The trajectory of the Covid pandemic is difficult to predict, given still-elevated global cases, the emergence of new strains, and lingering uncertainties about the roll-out of vaccines worldwide.
Such external shocks could slow the recovery. In light of such Covid-related uncertainties, the MPC considered it appropriate to provide some forward guidance on monetary policy to facilitate policy predictability and decision-making by economic agents.
In the absence of unforeseen developments, the MPC expects monetary policy settings to remain unchanged in the near term. As the recovery becomes more durable and the economy returns to full capacity, the MPC expects any adjustments in the policy rate to be measured and gradual to achieve mildly positive real interest rates.
In reaching its decision, the MPC considered key trends and prospects in the real, external and fiscal sectors, and the resulting outlook for monetary conditions and inflation.
Monetary and inflation outlook
The MPC noted that financial conditions remain appropriately accommodative at this early stage of the recovery, with the real policy rate in slightly negative territory on a forward-looking basis. Private sector credit has seen an encouraging uptick since the last MPC meeting, driven by a continued rise in consumer and fixed investment loans on the back of SBP’s refinance facilities. As demand recovers and inventories fall in some sectors, working capital loans have also picked up for the first time since the onset of the Covid pandemic, although their level remains lower than last year.
Inflation pressures have eased since the last MPC, despite an upward adjustment in fuel prices. After remaining close to 9 percent in the preceding two months, headline inflation fell to 8.3 percent in November and further to 8 percent in December, the lowest rate since June 2019. This decline is mainly attributable to easing food inflation.
Owing to conducive weather and various measures taken by the government to address supply-side issues, the price of perishables, wheat, pulses and rice has declined. Moreover, core inflation has continued to remain relatively soft since the beginning of FY21, in line with the presence of spare capacity in the economy.
Inflation expectations of both businesses and consumers remain well-anchored and have declined in recent months. As a result, at this stage of the recovery, any further supply-side shocks from food or utility tariffs are unlikely to have a lasting inflationary impact through second-round effects.