SBP may cut policy rate by 50 basis points

After witnessing a lower than estimated inflation measured by re-based CPI at 11.56 percent in August 2011, the numbers for September will bring some positive news and the State Bank is likely to cut its policy rate by 50 basis points in the upcoming policy.
According to Topline estimates, YoY CPI may fall to 19-month low to range between 10.8-11.2 percent at September-end. "This expected ease in inflationary pressures would motivate the central bank to continue the process of monetary easing in the upcoming monetary policy scheduled for October 8, 2011," said Nauman Khan an analyst at Topline Securities.
Moreover, the government decision to part ways with the IMF would also provide domestic policymakers some room to develop a more indigenous growth oriented but risky plan to protect the nascent economic recovery, he added. Rebasing of the CPI culminating into reduced inflation projection coupled with expectation of further fall in inflationary pressure has a marked impact on secondary market dynamics.
The most demanded 1-year T-Bill yield has approximately eased by 28-30bps in last 1-week (post-publication of August CPI numbers) and this yield is down 31-33bps from last September 21 T-Bill auction cut off of 13.31 percent, he said. This shows that market participants have already factored in a higher than 50bps cut since the yield has trimmed down by 85-89bps following the announcement of last monetary policy in July 2011.
However, he said the upcoming T-Bill auction on October 5, 2011 (last before MPS) would further clarify the views of bankers and investors about the quantum of discount rate cut. "We expect cut-off yields to decline in the range of 20-40bps for various maturities in the upcoming T-Bill auction," Nauman added.
Talking about the policy rate, he said in the next monetary policy a 50bps cut is expected while another 50bps in November 2011 as recent downward revision in the inflation numbers has created a considerable room for the SBP to bring down policy rate while still keeping the real interest rates in positive territory.
However, keeping in view the commodity price risk faced by the external account which could render into higher PKR depreciation, supply constraint faced by the economy and the fact that monthly CPI inflation increase is still 1 percent since last 3 months, we think the SBP will follow a gradual reduction. "We feel that 50bps cut now will provide central bankers enough time to evaluate the external account, CPI trend, local currency and the dollar inflows in coming few months. And if everything goes well than another reduction of 50bps in November would be a better choice," Nauman said.