Artificial decline in inflation – raising hopes of monetary easing

On the inflationary side, headline inflation has declined to 13.04%YoY in Feb’10 which is lower than our projection of 13.5%YoY. This disparity has occurred because the FBS has surprisingly not taken into account the across-the-board 5%-6% hike in domestic petroleum prices which was implemented on 1st Feb’10 (please see the table below). What is even more surprising is that it has incorporated a MoM decline of 7.34%, 4.02%, 2.63% and 0.9% in respective prices of Furnace Oil, Kerosene, Diesel and Motor Spirit in measuring the CPI for February. This anomaly has caused the CPI to decline by more than the 0.3% reduction in SPI during the month, a decline which is not supported by the historical relationship between the two inflationary measures where CPI, due to its estimation methodology, is stickier in nature.

We would like to highlight that real interest rate as measured through headline inflation have risen to -0.5% from -1.18% in Jan’10. If the State Bank of Pakistan takes the latest inflationary numbers at face value, it could potentially cut the discount rate by 25bps in the upcoming monetary policy. However, we still maintain that the probability for monetary easing in the short term is low. The money market seems to be of the same view considering that primary yields have risen consistently in the last three Treasury bill auctions. However, as we have argued, the artificial drop in CPI inflation in Feb’10 might distort monetary policy expectation in the short term and hence might lower money market yields till the announcement of the monetary policy.

AKD Research

March 11 2010