Inflation as expected

Finally, the suspense is over. Full year inflation for FY10 landed at 11.73 percent, i.e. on the lower side of revised SBP forecast of 11.5-12.5 percent.
Compared with the last two years, which saw CPI inflation at 22.77 percent and 12 percent in FY09 and FY08 respectively, this is a sign of relief. But compared with October 2009, it is not.
Consumer prices have been sticky since November, though at different pace in different months; month-on-month CPI marked 0.65 percent in June, up from 0.6 percent in May.
Though, trimmed core eased to its 6-month low of 11.7 percent, which is a good sign, non-food non-energy number remained in double digits, which implies that declining trend in NFNE inflation is being checked by monetary pressures.
That, together with risks of firmer global oil prices and higher prices of non-perishable food items might keep CPI number on the up - at least in the first half of FY11. The 100 bps increase in sales tax and higher energy tariffs implemented retroactive w.e.f. from April will add further fuel.
These factors alone are contributing towards inflationary expectations - enough to keep central bank managers on their toes. But perhaps the single most deciding factor behind base rate decisions would stem from what happens in Islamabad.
If the government is able to keep its fiscal gap within limits and is able to plug it through the budgeted sources, there is perhaps little to fear.
But if the government is unable to do so, as is the case most likely and as is evident from concerned voices in banks treasuries, rate cut hopefuls would be greatly disappointed.
There is clear and present danger from the fiscal side, owing to which the government might have to resolve to high powered money creation through the central bank (after December 2010), or lure commercial banks with higher interest rates. And both have their own well-known evil outcomes.
The bottomline is that, so far as inflation is in double digits with inflationary expectations still wild, a rate cut might not be in the offing in the current fiscal year.