MPS: Hawks at bay

The monetary policy announcement is tomorrow. Considering the SBP’s forward guidance in the previous policy review, expect no change in the policy rate. Market rates have already priced in a 50-bps increase, as fiscal problems persist. The language in the policy statement and SBP’s views in the post analyst briefing session are important to anchoring market rates going forward.

The surveys conducted by CFA Society and Topline Securities are showing no-change expectations in March. Over 90 percent of participants from the CFA Survey expect no change in March while 54 percent expect no rate hike in May. The Topline Survey depicts show that 82 percent out of 118 participants expect no change while the rest are expecting an increase of 25-50 bps. Interestingly, in the previous poll during January, 75 percent were expecting status quo. The behavioral change is evident from the CFA poll too where in January, 10 percent were expecting a rate hike in March by 25-100 bps (7% were expecting a rate increase by 25-50 bps).

Between January and March, not only has inflation increased; market rates have also moved up. Despite this northward movement in market rates, a higher number of analysts are expecting status quo. This is perhaps due to the forward guidance given by SBP.

If the SBP spells out that analysts should expected a measured increase (if any) in May, and tamed increase in the medium term, then market rates may come down a bit post monetary policy announcement. Then the news of hiring of bank for issuance of Euro bond will lower the reliance on banks for government borrowing. This may also help reduce rates.

The point is that the SBP must be more open in its forward guidance to anchor market rates. Right now, 50 bps increase is already priced in. Over the last two months, supply side inflationary pressures have persisted. Food inflation is not under control. The electricity price increase happened, and there are chances of further increase in months to come.

International commodity prices are heading north – especially oil. The impact of oil is yet to be passed onto the consumers, but this has fiscal consequences as the government is losing on revenues. The impact of increase in oil and other importing commodities has yet to be reflected in the imports number. It is expected that March import numbers could be higher. However, the exchange rate appreciation in the past few weeks suggest that the external account position is not in a bad shape.

The SBP has lately been focusing on growth. The output gap for FY21 is estimated to be negative. The wage-spiral inflation is not on the surface. There are no demand side pressures on the inflation. The increase in CPI and SPI are primarily from the supply side. If these are not entrenched into wages and do not have a second-round consequences, hawks will remain numb.

In the last policy review, it was a unanimous decision -all the nine members voted to keep the policy rate intact at 7 percent. The SBP model-based inflation forecast for FY21 and FY22 have slightly moved upward. Though, the corresponding interest rate path was suggesting that inflation will remain in medium term target of 5-7 percent.

The hike in inflation forecast is based on the factors mentioned above – increase in energy tariffs, expected increase in oil prices and better growth outlook for FY21 and FY22. The impact of a likely further increase in energy and gas tariffs is not reflecting in SBP’s forecast. Rest of the variables are already incorporated in the SBP model.

Inflation in March is likely to be higher than 9 percent and double digit in the Apr-June quarter. This may bring hawks back to life. There could be some votes for rate increase, but majority may still want an accommodative stance. Not to mention, COVID third wave is in the air too to keep the hawks at bay.