With inflation sliding to a single digit for the first time in twenty-two months, is it a time to rejoice or to focus on its intrinsic reasons and worry about its trend in the following months.
The decline in headline numbers to 8.9 percent last month is mainly due to the high base affect, as CPI was 25 percent in October 2008, amid lower commodity prices. Likewise, although the CPI-heavy weight food basket inflation is down to 7.5 percent, month-on-month inflation is gathering pace. As overall CPI rose 1 percent in October over September, food inflation jumped 1.1 percent - double the growth seen in September.
The case for coming months is simple on some basic arithmetic; assuming the Jul-Oct average of 1.2 percent, full-year inflation may be well in double digits even in this calendar year and can potentially cross 14 percent by the end of fiscal year. This may take the yearly average to over 12 percent, significantly above the budgeted target of below 10 percent. (See graph for inflation sensitivity to different monthly changes)
Mind you, this simple math does not account for, northward movement of commodity prices which is a possibility based on short-term global recovery and 25 percent increase in electricity prices in a phased manner during this fiscal year.
Enough of number crunching, lets delve into the factors that govern the fate of monetary policy. With trim core inflation down to 10.6 percent in October i.e. 240 bps lower than the current policy rate, coupled with 89 percent fall in current account deficit amid substantial decline (20%) in non-oil import bill during first quarter, further reduction in discount rate is imminent. The argument is strengthened by a stable outlook of rupee against dollar owing to continuing depreciation in real effective exchange rate.
The question is what will be the quantum of rate cut in the upcoming review and its course in the subsequent reviews. Lets take the words from horses mouth: "We need to be careful about moving too fast so that inflation is not let loose again we look forward to some relaxation in our monetary stance" said the governor SBP a couple of days back. The rise in electricity rates, risks to oil prices and fiscal pressure owing to war related costs urge caution, he further cited.
Hence, a cut of 50 - 100 bps is very much on the cards on SBP upcoming review late this month. The fall in inflation and improvement in external account position amid subdued private credit pleads the case.
But, as the inflation is bottoming out, the risks to sharp rebound are tightening SBPs hands. The EIA has recently revised its oil price forecast up to $77 per barrel for winters - but historically, oil prices have moved much more than the EIAs forecast. These factors coupled fiscal financing, which has emerged as a vital factor in recent past, from domestic sources will keep the policy rate in check after November.