First cut in 4 years: SBP reduces key policy rate by 150 basis points, takes it to 20.5%

The State Bank of Pakistan’s (SBP) Monetary Policy Committee (MPC) decided on Monday to reduce the key policy rate by 150 basis points (bps), taking it to 20.5%, effective from June 11, 2024.

In its statement, the MPC said that while the significant decline in inflation since February was broadly in line with expectations, the May outturn was better than anticipated earlier.

“The MPC assessed that underlying inflationary pressures are also subsiding amidst a tight monetary policy stance, supported by fiscal consolidation,” it said.

“This is reflected by continued moderation in core inflation and ease in inflation expectations of both consumers and businesses in the latest surveys.

“At the same time, the MPC viewed some upside risks to the near-term inflation outlook associated with the upcoming budgetary measures and uncertainty regarding future energy price adjustments. Notwithstanding these risks and today’s decision, the Committee noted that the cumulative impact of the earlier monetary tightening is expected to keep inflationary pressures in check.”

This is the first cut in the key policy rate in four years. The last time the central bank reduced the rate was in June 2020 during the pandemic. Since then, the interest rate has gradually gone from 7% to a record high of 22% where it stayed for almost a year.

MPC also emphasised that future monetary policy decisions will remain data-driven and responsive to evolving developments related to the inflation outlook

The MPC noted that since its last meeting, real GDP growth has remained moderate at 2.4% in FY24 as per provisional data, with subdued recovery in industry and services partially offsetting the strong growth in agriculture.

“Second, reduction in the current account deficit has helped improve the FX reserves to around US$9 billion despite large debt repayments and weak official inflows. The government has also approached the IMF for an Extended Fund Facility, which is likely to unlock financial inflows that will help in further build-up of FX buffers. Lastly, international oil prices have declined, whereas non-oil commodity prices have continued to inch up.”

“Based on these developments, the Committee, on balance, viewed that it is now an appropriate time to reduce the policy rate. The Committee noted that the real interest rate still remains significantly positive, which is important to continue guiding inflation to the medium-term target of 5-7%. The Committee also emphasised that the future monetary policy decisions will remain data-driven and responsive to evolving developments related to the inflation outlook.”

Background

With inflation readings registering a significant decline and the commencement of policy rate cuts by central banks worldwide, majority of the market expected Pakistan’s central bank to ease its monetary stance.

The SBP last made a move on the key policy rate in June 2023, when it raised it by 100bps in an ‘emergency meeting’. Since then, in seven huddles, the SBP kept the key policy rate unchanged at a record 22%.

During this time, decelerating inflation led many to believe that a monetary easing cycle was set to begin.

Economic activity has been slow in the South Asian country for the last two years after the government implemented tough reforms under an International Monetary Fund (IMF) bailout in a bid to stabilise a crumbling economy.

However, the phase is not yet over as Islamabad is again in talks with the IMF for a new longer-term bailout after completing a short-term programme earlier this year that helped the nation avoid a default.

What did analysts say before announcement

Market experts were of the view that the central bank might opt for easing of monetary policy amid a downward trajectory of the inflation rate.

Some had said that developments including a fall in CPI inflation, a manageable current account, stable local and international oil prices as well as a stable currency could be factors advocating a rate cut.

A report by brokerage house Arif Habib Limited (AHL) – in which it cited a poll result that suggested 73% respondents expect SBP to ‘reduce the policy rate’ in the upcoming announcement, while the remaining 27% see no change – said market sentiment also suggests expectations of a rate cut.

“We are expecting a reduction of 200bps in the policy rate, potentially lowering it to 20%, a level last seen in Mar-Apr 2023,” AHL said in its report.

Back then, the MPC viewed that the level of inflation is still high.

“The recent geopolitical events have also added uncertainty about their outlook. Moreover, the upcoming budgetary measures may have implications for the near-term inflation outlook,” the committee had stated back then.

However, AHL in its report was of the view that its projection of a rate cut is underpinned by several favorable economic indicators i.e. lower inflation, decline in current account deficit and government yields, suggesting a conducive environment for initiation of reversal in monetary stance.

“One of the primary factors supporting the expectation of a rate cut is the downward trajectory of Pakistan’s inflation. Both headline and core inflation figures have shown significant improvement,” it said.

Meanwhile, another brokerage house Topline Securities also suggested a similar expectation.

“We continue to believe that soon SBP will cut interest rate as real rates now at record high level of note than 1,000 basis points,” Mohammed Sohail, CEO Topline Securities, said in a note.

Last week, Finance Minister Muhammed Aurangzeb said he expects the policy rate to decline this year on the back of a significant decline in the inflation rate, which has come down from a peak of 38% to a little over 11% in May.

“While this is very much in the domain of the central bank, we do expect that the policy rate will start moving down in line with inflation, because we now have enough cushion in terms of the positive real interest rate that we need to maintain,” said Aurangzeb.

Some analysts, however, still advised caution as the upcoming budget announcement may contain inflationary measures.

Previous MPC meeting

In its previous meeting on April 29, the MPC had kept the key policy rate unchanged at 22%, which was in line with market expectations, its seventh successive decision to maintain the status quo.

“The recent geopolitical events have also added uncertainty about their outlook. Moreover, the upcoming budgetary measures may have implications for the near-term inflation outlook,” the MPC had stated back then.

Since the last MPC in April, several key developments on the economic front took place.

The rupee appreciated a marginal 0.07%, while petrol prices increased over 9.5%.

Internationally, oil prices remained largely stable and were hovering near $80 per barrel amid hopes of rising fuel demand this summer

The Consumer Price Index (CPI)–based inflation clocked in at 11.8% on a year-on-year basis in May, the Pakistan Bureau of Statistics (PBS) revealed, much lower than the reading in April when it stood at 17.3%

In addition, Pakistan’s current account posted a surplus of $491 million in April 2024, a significant jump compared to the revised surplus of $434 million in the previous month.

Foreign exchange reserves held by the SBP decreased by $100 million on a weekly basis, clocking in at $9.109 billion as of May 24, data released on Thursday showed.

Total liquid foreign reserves held by the country stood at $14.216 billion. Net foreign reserves held by commercial banks stood at $5.106 billion.