The consumer price inflation (CPI) has kept moving up; and it is likely to go further up in months to come, especially considering that in that recent reports both Nepra and Ogra have pointed to an increase in power and gas tariffs in the foreseeable future.
The headline number for July 2018 stood at 5.8 percent; a bit higher than market expectations. Yet again the house rent index quarterly increase was higher than the norm (which explains why the market was wrong) leading to hike in core inflation that stood at 7.6 percent last month.
The house rent is computed once every three months; and in April 2018 it was unexpectedly increased to 3.1 percent on monthly basis (effectively quarterly increase) as against an average of 1.6 percent in the previous 28 quarters. Had that been an outlier, the house rent index should have normalized in Jul18 - but the rise stood at 2.0 percent. This implies that the higher increase is a new norm in the housing market and this could be attributed to difference in computation methodology.
Anyhow, the timings of change are no good as sharp currency depreciation amid increasing commodity prices have also triggered the second round of inflation. The core inflation which jumped from 5.8 percent (Mar18) to 7.0 percent (Apr18) due to abrupt change in house rent index has already changed the outlook for FY19. Another worrisome fact is the steep increase in the wholesale price index (WPI).
The impact of currency and commodity prices is now visible in the sharp rise in WPI in the last two months. It was 5.6 percent in May 2018 which increased to 7.6 percent in June 2018 and 10.5 percent last month. The WPI is a leading indicator; prices increase or decrease in the wholesale market before their impact hits the retail market.
Thus, get ready for some increase in headline inflation in the months to come. By Dec 2018, it would not be surprising to see the CPI touching 8 percent; much higher than the yearly target. The monetary policy finally anticipated the gravity of the issue and has increased the policy rate by 100 bps to 7.5 percent in July 2018.
However, that is not going to be enough; in order to anchor demand, curb imports and to curtail inflation further monetary tightening is warranted. This is visible from the recent T-Bills auction where the market only bid for 3-month papers with no appetite for even 6-month paper let alone 12-month bills, implying that the market is expecting further increase in rates.
The question is how much of the interest rate hike is required. It’s hard to give a number as it all depends upon external inflows that give a direction to exchange rate, and in turn inflation. The SBP should have a keen eye on latest inflation, external and fiscal accounts numbers before taking any decision.
A good proxy is to look at the inflation numbers in October 2014. The core and headline numbers were 7.8 percent and 5.8 percent respectively back then versus 7.6 percent and 5.8 percent in July 2018. The inflation numbers today are almost same as it was in October 2014. At that time the discount rate was 10 percent while today it’s at 8 percent (policy rate:7.5%). This simple analysis suggests that there is some room for the increase in policy rate; the sooner it is, the better it is for anchoring inflation to FY19 target of 6.0 percent.