Inflation outlook not very encouraging

The State Bank of Pakistan on Monday said inflation outlook was not very encouraging and broad-based inflationary pressures were suggesting that inflation had permeated to most sectors and will be difficult to curtail in the short run.
According to the State Bank's third quarterly report international crude oil prices have increased by around 40 percent since the beginning of FY11, following unrest in the Middle East and a shift from nuclear to thermal power generation in Japan after the earthquake.
Overall, no significant easing in oil prices can be expected at this stage. In addition, the increase in palm oil prices is likely to impact domestic prices of vegetable oil and ghee. However, following a good Rabi season, wheat and sugar prices have come down, which should contain, and perhaps ease food inflation in the months ahead, the report said.
According to report recent trends in CPI inflation suggest that the impact of floods on prices has clearly worn-off, but in overall terms, inflationary pressures remain quite strong as Jul-May FY11 CPI inflation of 14.0 percent is considerably higher than 11.7 percent in the corresponding period of FY10. Nevertheless, we expect CPI inflation for FY11 to remain close to 14.0 percent - an improvement over SBP's earlier projections, the report added.
"Although high inflation is always a major source of concern for the central bank, some recent trends are disconcerting. Firstly, inflation remains stubborn. Secondly, inflationary pressures are broad-based, suggesting that inflation has permeated to most sectors and will therefore be difficult to curtail in the short run. Finally, although food inflation may decline in the coming months, overall inflation may not subside in the near future," the report said.
Wholesale prices increased sharply, reaching 25.9 percent in April-the highest level in 30 months, before slowing down to 22.9 percent in May 2011. Non-food items like POL products and cotton have largely accounted for the up-trend in wholesale prices. According to report while cotton prices have dropped after March 2011, POL prices have not. Since POL prices pressure tend to spill-over to other items in the CPI basket, overall inflation seems unlikely to recede too sharply in the coming months.
Unfortunately, the rebound in global commodity prices may fuel expectations that inflation in the country will remain stubbornly high in the near future. Moreover, the general public has also come to expect increases in fuel prices, electricity tariffs and the imposition of the general sales tax, thus reinforcing inflationary expectations. Finally, the expected removal of various subsidies under the auspices of the IMF could also add to the problem, the report observed.
"Thus, the outlook for overall inflation, even in the absence of food or energy shocks, is not very encouraging. Although we expect food prices to provide some room for comfort, self-fulfilling inflationary expectations have ingrained themselves in the economy and consequently, inflation is not expected to ease substantially in the near future," the report said. On the external front, oil prices are expected to increase in the summer with increased demand from China, US and a recovering Japan. Higher, persistent core inflation has left the economy more vulnerable to such external pressures.