KARACHI, Feb 14: Inflation rose to 8.51 per cent in the year to January 2005 from 7.37 per cent year-on-year in December 2004. In July-January 2004-05, the rate of increase in inflation was 8.76 per cent , data released by the Federal Bureau of Statistics show.

This increase in inflation, measured through consumer price index or CPI, in the first seven months of the current fiscal year indicate that the full fiscal year inflation would be higher than the revised target of 7 per cent.

Initially, the government had set inflation target at 5 per cent and GDP growth target at 6.6 per cent. But recently the National Credit Consultative Council that draws national credit disbursement keeping in view the growth in GDP and inflation revised both targets at 7 per cent.

The State Bank had started tightening interest rates back in February 2004 anticipating a higher inflation for the current fiscal year than the last year's 4.6 per cent--and it sped up the process in July, the first month of the new fiscal year. But the pace of tightening of interest rates was apparently slow.

The central bank defended this action during the first half of the fiscal year saying that a gradual and measured tightening of interest rates was a must to contain inflation without stifling growth. But in its monetary policy for the second half of the year it indicated that it would go faster on tightening the interest rates if inflation refused to decline. It kept its words and increased treasury bills rates by wider margins than in the second half.

However, increase in the prices of petroleum products and food items in December 2004 pushed up year-on-year inflation to 8.51 per cent for last month and both food and fuel inflation are likely to move further up in the remaining part of the year.

Pakistan kept domestic prices of petroleum products unchanged between May and November 2004 despite a spike in their international prices during this period. But it let the prices of these products rise from December and in so doing let the prices rise by a wider margin than the increase in global prices - and at times also allowed domestic prices when international prices remained stable.

The increase in oil prices, unlike the increase in the prices of other items, leads to an indirect increase in the prices of almost all the 374 items in the basket of CPI. That explains why inflation moves faster after oil price hikes.

Food prices that account for 40 per cent of CPI inflation also rose by more than 10 per cent year-on-year in January 2005 despite import of more than a million tons of wheat, the shortage of which had pushed up food prices earlier. In January, sugar prices also shot up forcing the government to allow import of raw and refined sugar. This is sure to push up food inflation for February 2005.

With the year-on-year inflation at 8.76 per cent in the first seven months of this fiscal year, the case for faster interest rate tightening has become stronger, all the more because non-food, non-fuel inflation has is also nearing 7 per cent-the revised target for overall CPI inflation for this fiscal year.

The State Bank is going to sell Rs70 billion three-month and one-year T-bills on Wednesday. The increase in the bills yields in this auction would show how aggressively the central bank wants to tighten interest rates to contain inflation.

Some bankers close to the State Bank say the Bank may also increase its discount rate, unchanged at 7.5 per cent since November 2002, sometime during this quarter or early next quarter to reinforce its earlier signals of interest rates tightening. But no official word is available on this subject.