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The headline average inflation stood at 8.9 percent in FY21 as compared to 10.7 percent in the previous year. This is at the upper band of the SBP’s expectation of 7-9 percent at the start of the year. The gap between rural and urban inflation has widened in FY21 – urban average inflation is at 8.2 percent versus rural at 10.0 percent as compared to 10.2 percent and 11.6 percent respectively the previous year.

In Jun-21, yearly inflation stood at 9.7 percent – a slightly better number than expectations. The gap between the rural and urban is thinning with June numbers converging to 9.7 percent for both. As pointed out by Optimus Capital, the headline inflation in FY21 is a tale of two halves – with Jul-Jan inflation averaging at 8.2 percent and Feb-Jun at 9.9 percent. This is largely due to the increase in electricity prices and that increase will remain intact for another seven months.

Nonetheless, the base effect is going to be favorable in the first half of FY22 and that is likely to keep the headline number relatively tamed. Having said that, the recent increase in international oil and other commodity prices along with wage increases in the recent budget would keep the monthly inflation uptick high.

In the last monetary policy announcement, there was one vote for the rate increase. And the committee highlighted the risk of oil prices. In the case of an oil price shock in FY22, the committee suggested raising the policy rate to bring headline inflation back towards the medium-term target range. Seeing the language of MPC minutes and a bullish outlook on oil, there is a high chance of 50-100 bps increase in rates in the next few policy reviews.

In FY21, for the second consecutive year, food inflation remains in double digits and remained the prime reason for higher inflation. Food inflation is up by 13.2 percent in FY21 and that is primarily due to non-perishable items – up by 15.9 percent. That increase is likely to be permanent and the higher prices are likely to be sticky.

There are number of food items where inflation remained in double digits – higher increase in urban food CPI is in chilies powder (90.8%) –, eggs (43.8%) as the chicken and eggs price game was highlight of food inflation in the past few months, sugar (22.9%), vegetable ghee (19.2%) and wheat flour bag (16.4%) to name a few.

In the next few months, there could be some inflationary pressure due to higher commodity prices around the world. The government is not passing the impact of higher oil prices to petroleum consumers. Let’s see how long this can be resisted. The transport inflation remained subdued (at 1.2%) in FY21.

The other sectors where inflation remained low in FY21 are education (1.28%) and this could be attributed to lockdowns as education mainly moved online in the last year. Recreational and culture sub index is up by 4.5 percent. Again, COVID is has shrunk demand for these activities. The best performer is communication where prices are up 0.7 percent. On the other hand, health inflation is slightly higher at 8.4 percent. The main support to CPI is coming from heavyweight housing and utilities index (27% weight) which is up by 6.3 percent in FY21.

That is why the core inflation has remained subdued. The average urban core inflation is recorded at 6 percent in FY21. The core inflation was moving up during Jan to April and now it is easing again. It stood at 6.7 percent in June. However, there will be some pressure on core inflation (or largely non-food inflation) due to the increase in wages and higher commodity prices which will impact the prices of various goods and services. The other pressure on the inflation is likely to come from passing on the higher oil prices impact to the consumers. Recent movements in SPI and WPI are suggesting the same as it stood at 17.6 percent and 20.9 percent respectively in June.

The bottom line is that the inflation dragon is not dead. The demand sides pressures are likely to build in FY22. And SBP may get in action to bring inflation towards its medium-term outlook of 5-7 percent.

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