High oil prices in the world market would impact domestic inflation in the months ahead, and annual CPI inflation is likely to be in the range of 11 to 12 percent in FY10, according to SBP''''s second quarterly report. An increase in domestic inflation has mainly been attributed to a rise in the administered prices of energy and key fuels by the government, exchange rate pass-through, and a temporary supply shock in January 2010 due to bad weather in Punjab.
Moreover, relatively higher international commodity prices of sugar, tea, pulses, rice, and crude oil also fuelled inflationary pressures in the economy. "The fear of renewed inflationary expectations, due to an inevitable reduction in subsidies on power and indications of strength in aggregate demand, contributed to the central bank''''s monetary policy committee decision to keep the policy interest rate unchanged in January 2010," the report says.
However, resurgence in inflationary pressures due to revival in aggregate demand, exchange rate pass-through, have, so far, not exceeded levels already embedded in the earlier SBP forecasts. Therefore, annual headline CPI inflation projection for FY10 also remains unchanged and it is estimated to be in the range of 11.0 percent to 12.0 percent, the report says.
The inflexibility in inflation is principally due to rising international prices of many commodities amid supply shortages and a recovery in the global economy weakening of the rupee, particularly in December 2009 and January 2010, when SBP stopped providing forex liquidity support for oil imports, the report adds.
"At first glance, it appears that the inflationary pressures are concentrated in food and energy sub-groups of CPI. However, the fact that the ''''trimmed mean'''' core inflation measure continues to rise despite a decline in non food-non energy core inflation indicates that inflationary pressures are strengthening in the economy".
Indeed, ample domestic stocks of key staples and improved production of minor crops played an important role in bringing inflation down to 8.9 percent YoY by October 2009, 16.1 percentage points lower than a year ago, before it bounced back into double digits, reaching 13.0 by February 2010.
Headline CPI inflation bottomed out at 8.9 percent in October 2009 before rising to 13.0 percent in February 2010. However, this remains lower than the 21.1 percent in February 2009, and 13.7 percent in the preceding month.
The SBP forecasts indicate that inflationary pressures are likely to persist, going forward. This view is endorsed by most commodity analysts, who believe that crude oil prices would average above $80 for the remaining 9 months of FY11. This would also impact domestic inflation in the months ahead. In view of these factors, SBP forecasts remain unchanged, indicating that annual CPI inflation would fall in the range of 11-12 percent in FY10.