CONTINUING ongoing monetary easing, the State Bank has slashed its key policy rate by 200bps from 19.5pc to 17.5pc for the third time since June. Cumulatively, the bank has sliced the interest rates by 450bps from the decade-high of 22pc in three months.

The fresh reduction in the borrowing costs shows the central bank’s confidence over recent economic stability amid hopes that the IMF Board would approve the new loan programme by the end of this month. The rate cut was widely anticipated amid a sharp drop in headline inflation to a single digit in August, and growth in the delta between the current CPI reading and the SBP’s policy rate to 10 percentage points.

The surprise in the policy decision was the quantum of the rate reduction. The bank said its decision was informed by the sharp fall in both headline and core inflation. The faster disinflation, resulting from a delay in the implementation of the planned increase in the administered domestic energy prices, as well as the decline in global oil and food prices has somewhat exceeded SBP expectations.

Additionally, the rate cut is driven by a sharp fall in global oil prices despite market volatility, stable SBP forex reserves at around $9.5bn in spite of weak official inflows and continued debt repayments, and improvement in inflation expectations and business confidence. Still, the quantum of the latest rate cut is believed to have been dictated by a large decline in the secondary market yields of government securities.

While there is no uncertainty about continued monetary easing over the next few reviews, experts are divided on the extent of future rate cuts and the pace at which these should be done. The delta between inflation and policy rate suggests another couple of sharp rate cuts in November and December. But if future monetary policy is to continue focusing on maintaining positive real interest rates to lower inflation to the 5pc-7pc target by the end of next September and ensure macroeconomic stability, the pace of future rate cuts would have to be slowed down.

The SBP itself has underlined that the near-term inflation outlook is susceptible to risks. Core inflation is still high and consumers’ inflation expectations increasing further. Also, there is uncertainty stemming from the timing and magnitude of adjustments in administered energy prices, the future course of global commodity prices, and any additional taxation measures to meet the shortfall in revenue collection.

On balance, the bank’s view is that average inflation will fall below the forecast range of 11.5pc-13.5pc for FY25. But this will depend on targeted fiscal consolidation and the timely realisation of planned external inflows. Thus, it would be prudent to first evaluate how enduring the plunge in inflation is before slashing the rate further.

Published in Dawn, September 13th, 2024