KARACHI, Feb 11: With consumer inflation reaching at 3.38 per cent in the first seven months of this fiscal year the State Bank on Wednesday reinforced its earlier signal that interest rates have bottomed out.

The central bank sent this signal to the market by selling double the targeted amount of treasury bills and in turn keeping its cut-off yield from falling below the previous level.

The SBP sold Rs29.5 billion six-month TBs against the target of Rs15 billion at the cut-off yield of 1.72 per cent-up from 1.71 per cent last month. The weighted average yield moved up to 1.67 per cent from 1.64 per cent in January.

Bankers said this reinforced earlier SBP signal that it did not see further fall in interest rates. "The SBP message is clear: interest rates have bottomed out and they can move up if the need arises," said treasurer of a foreign bank.

In the last auction of six-month TBs held in January the SBP had allowed the cut-off yield to inch up from 1.65 per cent to 1.71 per cent. The central bank had done this in what was largely seen by bankers as a signal that interest rates have bottomed out.

On Wednesday the SBP had to sell treasury bills worth almost double the target of Rs15 billion to keep this cut-off from falling and reinforce its earlier signal.

"We are alive to the challenge of inflationary pressure on the economy," said a senior central banker when asked by Dawn why the SBP did not allow the TBs cut-off to fall by sticking to the sale target.

"We have sent a signal to the banks and they are sensible enough to pick it," he said implying that SBP had indicated to the banks that the interest rates would not fall further. That exactly is in line with the SBP monetary policy stance.

SBP said in its monetary policy statement issued last month that it would maintain the current neutral stance but would possibly change it if inflationary pressure builds up further.

That the inflationary pressure has been there is clear from the data released by Federal Bureau of Statistics on Wednesday. The data shows that inflation measured by consumer price index rose 3.38 per cent between July 2003-January 2004 over a year-ago period.

The government had originally projected 3.9 per cent inflation for the current fiscal year but the SBP projected in its first quarterly report that it could settle somewhere around 3.6-4.2 per cent.

A sharp increase in currency in circulation (CiC) coupled with an all-time-high offtake of private sector credit show that CPI inflation may even cross the higher side of the said projection.

Between July 1, 2003 and January 24, 2004 CiC shot up by Rs88 billion and net private sector credit offtake reached a record level of Rs206 billion. Some other components of Monetary assets or M2 also showed a sharp increase whose combined effect was that M2 grew by 9.35 per cent during less than seven months of this fiscal year. The full year target is 11.06 billion which central bankers say privately may be missed.

Since the increase in CiC accounted for 45 per cent of increase in M2 the possibility is that it would further push up inflation in February. Similarly, since a part of the huge private sector credit volume is being used in non-productive sectors this too may fuel inflation.

But since large scale manufacturing showed a high growth of 13.5 per cent in the first half of this fiscal year the optimist can assume that a large chunk of private sector credit is being used for production.

"Production. Output. That is what matters more for an economy like ours," said a well-known economist Dr Shahida Wizarat. Talking to Dawn over telephone, she said it would be premature to comment on whether the inflation target would be met. "Let us wait and see."

"But even if for the sake of argument it is assumed that the inflation would be a little higher than target that should not necessarily prompt the SBP to tighten its monetary policy," she said.

"We need to increase output and reduce unemployment. If that means a little bit increase in inflation let it be so. After all the cost of inflation is shared across the board," said Dr. Wizarat. "On the contrary when inflation is contained but output falls and unemployment soars it is the vulnerable groups of the public that suffers most."