The headline inflation is surprisingly down to 3 percent in August 2025 as against the street view of 4 percent. On a month-on-month basis, CPI is down by 0.7 percent while the market was expecting a surge of 0.3–0.4 percent. Inflation averaged 3.5 percent in 2MFY26 as compared to 10.4 percent in the same period last year.
The divergence from expectations in August is due to a sharp decline in fresh fruit and vegetables, whose prices are down by 18–20 percent MoM and have dragged the inflation down by 0.6 percent. The fall is counterintuitive, as usually fresh fruit and vegetable prices move in the same direction with onions and tomatoes—both are up 20 percent and 14 percent respectively in urban areas.
Urban inflation stood at 3.4 percent while the rural index is up by 2.4 percent in August. Food prices are negative in both settings—down by 0.5 percent and 1.3 percent, respectively. The year-on-year decline in food is due to the base effect, and it will vanish in a few months’ time, as both wheat and sugar prices are moving upward.
Overall, country-wide food inflation stood at minus 1.8 percent in August and the 2MFY26 average is at minus 0.5 percent as compared to 3.9 percent last year, while it averaged 35 percent in the previous two years. Food prices rose sharply and now have fallen too. The volatility in food prices is likely to continue as non-perishable food items are already moving up, while after the floods perishable food item spikes are very much possible too.
After food, the second-highest weight in CPI is of the housing and utilities sector, whose inflation stood at 3.6 percent in August, and it is negative 1.4 percent MoM due to a 7.6 percent decline in liquefied hydrocarbons and a 6.9 percent fall in electricity charges. The third item which has negative inflation MoM is transportation—down by 1.0 percent due to a 1.5 percent dip in motor fuel.
Thus, food and energy prices are tamed and mostly fell in the last month. However, the story is different for other areas. Inflation (YoY) is still in the double digits for health (10.6%), education (10.9%) and miscellaneous (14.4%).
That is why the decline in core inflation is much less than that of food—urban core stood at 6.9 percent while rural core is at 7.8 percent as compared to 10.2 percent and 14.4 percent in the same period last year.
There are risks of an inflation upsurge in the months and quarters to come. The base effect benefit is over and now it’s likely to reverse in a few months. The decline in August is an anomaly, as food prices—especially fruits and vegetables—are already moving higher. The supply chain disruption due to floods is resulting in a spike in prices, while potential agricultural losses could result in a further increase in food prices.
Sugar prices are up 22 percent in August from the same period last year. Wheat is down, but recent SPI trends suggest that wheat price reversals have already started.
With some economic recovery, the pressure on wages is growing, which is evident from the sharp increase in wages in the financial sector—others are likely to follow, and that could have an impact on demand. Plus, the impact of reducing interest rates by half would result in a demand pickup. The blind spot is floods, which could have an impact on inflation.
The point is that SBP should not get carried away with August’s low CPI and should wait for the impact of floods on inflation and the external sector before any further reduction in the policy rate.