The headline inflation is heading south; but the core inflation is moving up, and latter's increased impact is more than offset by low food inflation. especially perishable items. The CPI clocked at 3.7 percent in January with no surprise, as analyst community was expecting the same. The 7MFY17 inflation is at 3.9 percent, and the full year number will likely remain below the SBP's target of 6 percent.
On monthly basis, CPI inched up by 0.2 percent in January as compared to a decline of 0.7 percent in the previous month. What has triggered the increase in January? Nothing; but the recording of house rent index, which takes place once a quarter - it increased by 2 percent in January over the last month (effectively over a quarter), and its impact on CPI increase in January is around 0.4 percent; barring it, the CPI would have declined by 0.2 percent in January versus 0.7 percent fall in December.
The steep decline in perishable items is keeping CPI subdued lately. It fell by 8.5 percent in January; and its decline is 23 percent since October 15. Thus, almost a quarter decline in perishable food items is driving the CPI downward movement. And the overall food index fell by 5 percent in the last three months.
The seasonal impact has, in the short run, diluted the impact of low base in the last two months; and has revised all the predictions slightly. The CPI may be tested a bit in February-April; but the base effect would be favourable again in May and June. The full year inflation in FY17 is likely to remain below 4 percent.
Some may feel that this is very encouraging and start advocating further ease in monetary policy in which the policy rate has been kept unchanged since May 2016. Yes, low inflation has kept hawks at bay; but that does not warrant any further easing. Within inflation, the core inflation has kept on inching up as it increased from an average of 4.6 percent in first quarter to 5.2 percent in the second quarter. In January, it clocked at 5.4 percent.
The number in January is pretty close to policy rate of 5.75 percent. There are signs that core inflation would keep on moving up as the M2 growth was 9.1 percent in Jul-Dec 16 versus 8.4 percent in Jul-Dec 15. The current account is in severe pressure lately with last two months deficit of $1.9 billion. This will keep on exerting pressure on the currency whose real appreciation is alarming as according to SBP the REER has reached 126. Once the currency dips, imported inflation is a consequence.
The other inflationary pressure is emanating from slippage in fiscal deficit, which was at 1.3 percent in the first quarter; and with new textile package and absence of any new taxes, the full year target of 3.8 percent of GDP will be missed by a wide margin. Within fiscal deficit financing., the onus is falling on central bank. This will fuel in inflation further.
Nonetheless, the problem of twin deficit will start hitting inflation with a lag; and so, the policy makers can live this fiscal year without any increase in the interest rates.
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