Pakistan set to hold rates as Israel-Iran conflict overshadows growth push: Reuters poll

A Reuters poll indicates Pakistan's central bank is expected to hold its policy rate at 12%, a shift from previous expectations of a cut, due to rising global commodity prices and inflation risks stemming from geopolitical tensions after Israel's military strike on Iran; while some analysts believe a rate cut could support GDP growth, concerns about imported inflation and external sector performance have led the majority to anticipate a hold, despite recent declines in Pakistan's inflation rate.

Analysis

The State Bank of Pakistan (SBP) is now widely anticipated to maintain its policy rate at 12%, a notable shift from earlier expectations of a rate cut, according to a recent Reuters poll where eleven of 14 respondents favored a hold. This change in sentiment is primarily attributed to escalating geopolitical tensions following Israel's military strike on Iran, which has stoked fears of rising global commodity prices, particularly oil, and the potential for increased imported inflation in Pakistan. S&P Global Market Intelligence highlights this risk, noting that higher commodity prices could reignite inflationary pressures, negatively impact Pakistan's external sector performance, and exert pressure on the exchange rate. While Pakistan's inflation has moderated significantly from its peak of approximately 40% in May 2023, it recently ticked up to 3.5% last month, exceeding the finance ministry’s projection, partly due to fading base effects; the SBP projects average inflation between 5.5% and 7.5% for the current fiscal year. This cautious stance follows a period where the SBP paused its easing cycle in March after 1,000 basis points in cuts from a record 22%, and then resumed with a 100-basis-point reduction in May. The decision also comes against the backdrop of a tight annual budget featuring a 20% rise in defense spending and a 4.2% GDP growth target, the achievability of which is viewed with skepticism by some analysts amid fiscal and external challenges, despite the stabilization brought by a $7 billion IMF bailout. A minority view, including Al Habib Capital Markets which forecasts a 50-bp cut, suggests that lower rates could support the GDP target and alleviate debt financing burdens.

Key Decisions for Investors

• Investors should closely monitor geopolitical developments in the Middle East and their consequent impact on global oil and commodity prices, as these are pivotal to Pakistan's inflation outlook and the SBP's monetary policy stance.
• It would be prudent to re-evaluate exposure to Pakistani assets, considering the heightened risk of imported inflation and potential renewed pressure on the country's external account and currency stability should the geopolitical situation deteriorate further.
• Pay keen attention to the SBP's upcoming policy statement for guidance on its assessment of inflation risks versus growth imperatives, especially in light of the government's 4.2% GDP growth target and ongoing fiscal constraints.