Monetary Policy Committee (MPC) of the State Bank of Pakistan will announce its bi-monthly monetary policy coming Friday (May 15, 2020) in which we expect the committee to cut Policy Rate by another 100bps.

The million dollar question right now is: why further policy rate cuts are needed? This answer to this question can pave the way for establishing rate outlook in FY21 as well. Our observation is that faltering consumption, inflation, asset prices and growth outlook altogether have created a perfect recipe for continued rate reduction.

The transmission channel of monetary policy has always been a big black box with varying relevance of each channel in different times. Out of the four well-established transmission channels (direct interest rate, bank lending, exchange rate and asset price), bank lending and asset price channel will be more relevant to achieve growth objectives under current circumstances.

In the face of low commodity prices, faltering inflation and waning industrial activity, inflation is unlikely to stage a comeback in 1HFY21. Reflationary aspects of loose monetary and fiscal policy will be much more profound from 2HFY21 onwards assuming the spread of COVID-19 slows considerably and life reverts back to normal.

After the upcoming MPC, expect another 50-100bps cut in Policy Rate during the rest of CY20. Coordinated monetary and fiscal easing amidst manageable external account outlook will be essential to weather the low-growth, low-inflation period.

Using equity market as a proxy for asset prices, benefits of rate cut will likely translate into higher prices for sectors with leverage such as cements, engineering, fertilizers, chemicals etc. but negatively affect banks and E&Ps. Depressed valuations of heavyweight banks & E&Ps however, will keep selling in-check, resulting into net positive outcome of policy rate on KSE-100. We maintain our index target of 38,500 for Dec’20. (BMA Capital Management Ltd.)