Monetary policy: the hold is defensible, the comfort less so

The MPC kept the policy rate unchanged at 11.5 percent on Monday. Hardly a surprise. But here is the kicker: the decision was unanimous. At the previous meeting, one member had voted for a rate hike. Since then, headline inflation has remained in double digits, core inflation is still above the medium-term target range, private-sector credit growth has accelerated, and financial conditions have eased. Yet rather than the hawkish camp gaining another vote or two, the dissent has disappeared altogether. Apparently, the MPC is now more comfortable with the inflation trajectory than it was before.

Maybe it has good reason to be. Broad money growth moderated to 13.2 percent year-on-year as of July 10, down from 15.2 percent at the time of the previous meeting. Reserve money growth has slowed as well, while the post-Eid reversal in currency in circulation, together with robust deposit growth, has brought down the currency-to-deposit ratio. More importantly, consumer and business inflation expectations have eased in the latest surveys. For an inflation-targeting central bank, that last bit should count for plenty.

But does it count for enough? Headline inflation may have eased to 11.1 percent in June, but remains well above SBP’s 5-7 percent medium-term target range; core inflation, at 8.4 percent, is hardly there either. SBP itself expects inflation to remain above target over the next few months before gradually settling near its upper bound by June 2027. The debate, therefore, is no longer about whether inflation has returned, but whether the latest outturns are temporary enough for expectations to remain anchored while monetary conditions continue to ease.

That question becomes more interesting when private-sector credit is added to the mix. Credit growth has accelerated to 14.9 percent, supported, in SBP’s own words, by “easing financial conditions”. Better still, from the perspective of economic recovery, the increase is broad-based across working capital, fixed investment and consumer financing, with textiles, telecommunications, and wholesale and retail trade among the major borrowers. After nearly three years of economic shock therapy, this is exactly the recovery policymakers should want. Private businesses cannot remain starved of credit forever, investment cannot recover without financing, and households cannot indefinitely be expected to celebrate macroeconomic stability while real incomes struggle to catch up. If stabilization is to mean anything, it must eventually translate into growth.

The trouble is that monetary policy becomes harder, not easier, when growth returns. During stabilization, compressed demand does much of the heavy lifting: credit remains weak, imports subdued, investment depressed and pricing power limited. Inflation expectations are hardly put to the test when everyone is too broke to spend. The real test begins when the cycle turns, credit returns, incomes recover, businesses regain pricing power, and pressure to loosen the purse strings begins to build.

That turn may already be underway. Automobile sales, cement dispatches, fertiliser offtake and business sentiment all point towards improving activity in June. SBP expects budgetary incentives, tariff rationalisation and private-sector credit to provide further support during FY27, with real GDP growth projected between 3.5 and 4.5 percent. Even the current account is expected to move accordingly: after closing FY26 with a modest deficit of $139 million, it is projected to widen as economic activity and imports recover. None of this is bad news. Quite the opposite. The economy has spent far too long in the ICU, and another year of anaemic demand masquerading as macroeconomic stability would hardly qualify as success.

But the timing could become awkward. The federal budget may not qualify as an old-fashioned fiscal stimulus. The government still targets a primary surplus of 2 percent of GDP and an overall deficit of 3.6 percent, while IMF conditionality continues to constrain how far Q-block can loosen the purse strings. Yet the direction of travel has unmistakably changed. Budgetary incentives are intended to support activity at a time when broader pressures for stronger demand, wage recovery, development spending and easier financing are already increasing.

After all, stabilization has already extracted its pound of flesh. Businesses want demand back, households want incomes to recover, provinces want development spending, and industry wants utilisation levels to rise. The government, meanwhile, has crossed the midpoint of its political term. If past is any lesson, the political economy of the second half of the cycle looks rather different from the first. Governments may enter office promising reform and stabilization, but few approach elections selling austerity; growth, jobs, wages, housing and development make for rather better campaign material. Does the MPC seriously expect pressures for accommodation to become weaker over the next eighteen months?

Which is why the policy rate itself tells only half the story. At 11.5 percent, it may still appear sufficiently restrictive on paper. But market rates have already adjusted lower, financing conditions have eased, and private credit is responding. Meanwhile, inflation has risen substantially from the unusually low readings seen earlier in the year. Even without another rate cut, the real degree of monetary restraint has already compressed. A policy rate of 11.5 percent today, therefore, does not represent the same monetary stance as 11.5 percent did several months ago. What matters is not merely where the policy rate sits, but where market rates, money growth, credit growth, nominal demand and inflation sit around it.

This brings the discussion back to expectations. SBP’s surveys suggest consumer and business inflation expectations have eased. That is important evidence and cannot simply be brushed aside because other indicators make for a more exciting story. But expectations are ultimately validated by behaviour and outcomes, not surveys alone. If households, firms and financial markets genuinely believe inflation will return sustainably to 5-7 percent, wage setting, pricing behaviour, credit demand and nominal spending should eventually reflect that confidence.

For now, the evidence is mixed. Headline inflation is at 11.1 percent, core inflation at 8.4 percent, broad money continues to grow in double digits, private credit is expanding at 14.9 percent, and financial conditions are easing just as economic activity begins to recover. Overlay that with a budget leaning towards growth at the margin, rising demands for incomes and development spending, and a political cycle moving into its latter half, and the inflation equation becomes considerably less comfortable.

The immediate inflation pressures may well remain supply-driven. Global commodity prices, domestic food prices, administered energy tariffs and input costs feature prominently in SBP’s own assessment, alongside climate risks and potential fiscal slippages. But whether the first-round shock comes from oil, wheat or electricity is beside the point for monetary policy. The problem begins when those shocks encounter sufficient nominal demand to generate second-round effects. The question is not whether inflation today is demand-driven, but whether current monetary conditions will remain restrictive enough to prevent today’s supply shock from becoming tomorrow’s demand-fuelled inflation.

The MPC clearly thinks they will. It expects inflation to remain above target for the next few months before gradually settling near the upper bound of the 5-7 percent range by June 2027. Unlike at the previous meeting, every member appears comfortable enough with that trajectory to keep rates unchanged. The hold is defensible; in fact, another rate cut would have been considerably harder to justify. But the degree of comfort implied by unanimity deserves closer scrutiny.

The monetary authorities spent much of the last cycle fighting an inflation problem after nominal demand had already run away. This time, they have the luxury of seeing the early signals while the recovery is still taking shape. Broad money, private-sector credit, market rates, real rates, imports and inflation expectations will tell soon enough whether the current stance has been calibrated just right. For now, the MPC would do well not to mistake a defensible hold for evidence that the difficult part is over.