The State Bank has reduced its benchmark policy rate by 200 basis points, from 19.5 percent to 17.5 percent, for the third time since June as part of continued monetary easing. In three months, the bank has collectively cut interest rates by 450 basis points, or 10%, from the decade-high of 22 percent.
In anticipation that the IMF Board would approve the new loan program by the end of this month, the central bank has recently reduced borrowing costs, demonstrating its confidence in the soundness of the economy. The rate reduction was widely expected in the wake of the headline inflation rate plummeting to zero in August and the current CPI reading and SBP policy rate differential widening to ten percentage points. How much of a rate cut was included in the policy decision surprised me. The major decline in headline and core inflation, according to the bank, influenced its decision. SBP projections have been somewhat exceeded by the quicker disinflation brought about by the postponement of the intended increase in administered domestic energy prices, as well as the drop in the price of food and oil globally.
The rate reduction is also fueled by a significant decline in world oil prices amid market turbulence, steady SBP foreign exchange reserves at roughly $9.5 billion despite minimal official inflows and ongoing debt repayments, and improvements in business confidence and inflation predictions. Still, a significant drop in the secondary market yields of government assets is thought to have determined the extent of the most recent rate cut.
Experts disagree on the scope and timing of upcoming rate reductions, even if it is certain that monetary easing will continue throughout the upcoming reviews. Another round of steep rate decreases in November and December is suggested by the difference between the policy rate and inflation. However, the rate of future rate decreases would need to be slowed down if monetary policy is to continue focusing on maintaining positive real interest rates in order to lower inflation to the 5–7% objective by the end of September of next year and maintain macroeconomic stability. The SBP has acknowledged that there are risks to the near-term inflation outlook. Core inflation is remains strong, and consumers’ expectations for inflation are rising. In addition, there is uncertainty over the timing and scope of changes to administered energy prices, the trajectory of commodity prices globally in the future, and the implementation of any further taxes to make up for any shortfall in revenue collection.
Overall, the bank believes that average inflation for FY25 will be lower than the predicted range of 11.5 percent to 13.5 percent. However, this will be reliant on early realization of scheduled foreign inflows and focused budget contraction. Therefore, it would be wise to assess the durability of the inflation decline before further reducing the rate.
