September 2024 inflation is expected at 7.9% YoY vs. August 2024 inflation of 9.6%. M/M inflation is expected to be around 0.3%, at the same pace as last year. We expect further interest rate cuts as the real interest rate differential is quite large. The SBP has room to further cut the policy rate to 15% based on our expectation of a 4% real interest rate differential and terminal inflation of 11% YoY.

However, we would highlight that MoM inflation has averaged 0.2% over the past six months, consistent with a 2.4% annualized inflation rate, barring any base effects. This pace of inflation, consistent with developed market economies, is unlikely to persist indefinitely. Historically, inflation has averaged at least 0.5% MoM in periods of low currency devaluation and higher when the Pak Rupee has depreciated.

While high interest rates, disinflation, and Balance of Payments normalization have given impetus to PKR stability, eventually, PKR devaluation has to conform to interest rate/inflation parity principles to avoid the buildup of future external imbalances.

It is also important to note that over the past six months, Food & Housing, roughly 60% of the index, has declined 1.5%. While these categories, by their weight, have a pronounced impact on headline inflation, the war on inflation is not yet won. Excluding these two categories, the other sub-groups have risen 5.7% in the past 6 months.

A similar scenario has played out with the BoE, ECB, and now the FED cutting rates; for central bankers, lower headline numbers have outweighed persistent service inflation in these decisions.

It remains to be seen how these cuts play out, and given the aggressive interest rate cuts that have already occurred, the SBP should adopt a cautious path. We remain committed to a medium-term Policy Rate of 15%; it remains to be seen whether the SBP aggressively cuts to that level before holding rates steady or adopting a more gradual path.

Courtesy – BMA Research