MPS: Hold your horses and the discount rate

With just a few hours remaining before the announcement of the State Banks monetary policy, consensus appears to be building about the expectation that the central bank will leave the benchmark rate unchanged. Twenty-four out of twenty-seven research houses contacted by BR Research related that they expect SBP to maintain the policy rate at 12 percent. On the other hand, three respondents opined that the discount rate may be hiked between 50 bps and 100 bps. In any case, most respondents are of the view that the monetary policy stance will be further tightened in coming months. But, without delving into predictions over subsequent monetary policy statements, it appears that status quo will likely be maintained for now. Inflation has averaged at 11 percent over the past 11 months; comfortably below the discount rate of 12 percent. Since inflation is within the target and in line with the policy rate - so this alone doesn warrant any hike in rates. And given the rationale that high interest rates act as impediments to private credit growth, the central may be bold in offering a slight cut in rates. But such boldness may not be on display tomorrow as a closer look at core inflation suggests pressure is piling up each month. In May, core inflation reached its highest level for the current fiscal at 11.1 percent while trimmed core inflation is even higher at 11.7 percent; leaving little scope for further easing. The other worrisome factor that is probably in the minds of the hawks in the camp is the mounting pressure on the currency. The local currency has depreciated by a whopping 4 percent since the announcement of the last monetary policy. Any easing out could exacerbate the situation by further stoking capital flight. After all, keeping a check on currency depreciation is also part of the SBPs mandate. But, look at the trends in global commodity markets. Prices are falling like nine pins. Mind you, persistent high double-digit inflation for the past five years is primarily attributed to supply side shocks mainly emanated from imported oil and other commodities. Oil prices have dropped by about 25 percent from their recent peak in March; cotton is less than half of its all time peak value, and story of urea is not different. Same is the case with virtually all the commodities with the exception of precious metals. The chances of this trend continuing over the next few months are high. Eurozone is at a worst junction; as Spain stands on the edge, just as Greece did before it. There are talks of double dip recession all around. The demand from West is not going to pick anytime soon. The eastern growth engines, China and India, are losing steam as well. So, inflation is likely to subside in coming months, along with pressure on the local currency which is primarily brought on because of the high import bill. This argument is good enough to corner the hawks in the room. But that doesn warrant keeping the risks of demand pressures aside which are by virtue of monetisation of fiscal deficit and domestic supply constraints owing to energy woes. And you can be certain on the outlook of commodity prices in the volatile and unpredictable world of today. So its better to maintain the wait and see approach.