Govt to Hike SBP Policy Rate in Case of High Inflation, External Pressures

The government has committed to the International Monetary Fund (IMF) to increase the policy rate if new inflationary pressures emerge or external pressures were to threaten external and financial stability. This has been noted in the Fund’s latest report “2024 Article IV Consultation and Request for an Extended Arrangement under The Extended Fund Facility”. The Fund has recommended that further lowering of the policy rate should be predicated on evidence that core inflation is moderating and inflation expectations have re-anchored. Recognizing the internal and external uncertainties, the monetary stance will remain cautious with a sizable positive real policy rate (currently about 10 ppts ex-post). The authorities believe that the restrictive stance contributed significantly to driving the fiscal year 2025 average inflation below the earlier forecast range of 11.5—13.5 percent. The Fund stated that monetary policy needs to remain tight and data-dependent to ensure that inflation converges promptly to the State Bank of Pakistan (SBP)’s target range. Policy rates will remain substantively positive in real terms and data-dependent to adjust quickly to evolving price dynamics, it added. The recent decrease in the policy rate was appropriate and consistent with a continued tight policy stance. Going forward, the SBP should remain vigilant as its fight against inflation is approaching the “last mile”, and any further lowering of the policy rate should be predicated on evidence that core inflation is moderating and inflation expectations have re-anchored. The Fund further recommended that renewed efforts are needed to strengthen monetary transmission while enhancing SBP’s safeguards in monetary policy operations is key to reducing risks to its balance sheet and strengthening governance. The report also stated that at the same time, to support monetary policy formation and implementation, the inflation expectation survey will be aligned with best practices. More broadly, reducing fiscal dominance and credit objectives will be conducive to stronger monetary transmission and foster financing deepening and allocative efficiency, including by The Pakistani authorities have committed to the Fund that monetary policy will remain appropriately tight to guide down inflation towards target alongside continued efforts to improve our policy frameworks and strengthen monetary transmission. They also committed to maintaining positive policy rates in real terms and continue a data-dependent approach, such that any lowering of the policy rate, which they expect to proceed very gradually given still elevated risks, would be predicated on clear evidence that inflation and inflation expectations are trending firmly downward. “We also stand ready to increase policy rates if new inflationary pressures emerge or external pressures were to threaten external and financial stability. Given the criticality of re-anchoring inflation expectations for enhancing central bank credibility, we will advance work to align our inflation expectations surveys with best practice by end-fiscal year 2025, and to strengthen our communication around policy decisions, we are considering the issuance of a dedicated monetary policy report”, the authorities added.