KARACHI: With subdued inflation expectations in near term, the analysts believe that bond market expectations of a 25bps cut in upcoming Monetary Policy Statement (MPS) in February 2017 has reignited again.
The State Bank of Pakistan (SBP) recently released minutes of the last monetary policy meeting held in November-2016, where, interestingly, the monetary policy committee members vote count in favor of rate cut increased to 4 from previous 2 (September-2016 MPS).
“This in our opinion has raised concerns over a possible 25bps cut in the upcoming monetary policy, which is further reinforced by earlier developments which involved lower inflation reading for December 2016,) government scraping off last Pakistan Investment Bonds (PIB) auctions owing to higher yield demands, cut-off yields coming off by 2-4bps in last MTB auction and secondary market yields also following suit”, said M. Ibad-ur-Rehman, research analyst at Elixir Research.
However, that said, we contend that the monetary cycle has bottomed out given rising pressure on government to pass on rebound in international oil price hike domestically, core inflation breaking out from 5 percent mark and eroding high base effect, he added.
Furthermore, minutes of the meeting also highlight SBP’s Forecasting and Policy Analysis (FPAS) model which suggests monetary conditions are still tight owing to persistent real exchange rate gap and lower large scale manufacturing growth in first quarter of FY17 and hence indicates further room for moderation in policy rate.
Inflation for the month of December 2016 clocked in at 3.70 percent, slightly easing off 0.6pp Month on Month (MoM), significantly below market consensus where greater than expected decline in food prices led to lower inflation reading. Core inflation on the other hand remained sticky, clocking in at 5.2 percent, an increase of 0.1pp MoM.
This takes average first half of Fiscal Year 2016-17 (FY17) inflation to 3.88/3.30 percent, compared to 1.80/3.44 percent in same period of last fiscal.While inflationary pressures are likely to increase in second half of FY17.
Owing to lower than expected inflation in Dec-16, the recent MTB auction by SBP saw yields on 3M/6M come off by 4/2bps with participation skewed towards 6M. This increased participation towards longer tenor marks a shift from the heavy participation witnessed earlier in three months, indicating that expectations of an interest rate lift off in the bond market have extended to mid-2017, Rehman said.
“We however maintain monetary cycle has bottomed out: However, that said, we maintain our stance that monetary cycle has bottomed out with interest rate lift off expected by fourth quarter FY17 (50bps hike). This is due to mounting challenges on the external front which include ballooning trade deficit and flattish remittances, narrowing real interest rates where we project it to fall to 0.3 percent by fiscal year end and overall aggregate demand pickup in the economy warrants a prudent monetary policy management”, said Rehman.
Furthermore while government has started to exhibit populist economic moves where it has recently announced Textile package worth Rs 100 billion along with keeping domestic POL prices intact despite rise in international oil prices, we believe possible move in second half of 2017 by government to rein in its fiscal deficit may invoke further inflationary pressures through increased tax mobilization, he concluded.