Morning Call about Inflation Preview – Arif Habib Limited

Karachi: High oil price to fog earlier easing temptations; for Mar-12 Arif Habib Limited expects CPI at 11%YoY

Mar-12 CPI inflation is expected to bounce back
Arif Habib Limited estimates Consumer Price Index (CPI) based inflation for the month of Mar- 12 to reach ~10.9% translating into a +~1.3%MoM rise over last month.

According to Arif Habib Limited, the monthly numbers are considerably higher when compared to the last month (+0.3%MoM). Even when compared to 7MFY12 monthly average of 0.9% rise.

Policymaker’s uneasiness
In Arif Habib Limited’s view, monthly increases in headline prices reflect a combination of factors. Relatively strong domestic demand, supply shocks –in the form of higher commodity prices – both from food and oil, slow policy responses and aggressive monetary expansion witnessed in FY11 and in the last leg of 1HFY12. However, just when Arif Habib Limited was tooting about possible implications of strong monetary growth on inflation, the policymakers now, have to deal with the problem of rising oil prices. And since these are externally driven price shocks, the State Bank of Pakistan (SBP) can do little to address the change. This puts policymakers in an uneasy position.

Choosing what to avoid
Arif Habib Limited is of the view that, just like it has been in the past, the government will be unwillingly to pass-on high oil prices on to the end-consumer, due to its unpopular political implication, especially when election round the corner. But just as with start of 2HFY12, the government has promptly responded to rising international oil prices and duly raised the domestic gasoline prices through separate notifications issued in Feb-12 and Mar-12, by Oil and Gas Regulatory Authority (OGRA). This lifts some of the burden on government’s books and thus led us to believe that the long-awaited fiscal prudency might just be coming in. But the likely outcome of the decision has put the SBP in a rather awkward situation. Put simply, what is that the policymakers most want to avoid for now. Higher oil induced inflation; which warrants a rate tightening or government taking a hit on its fiscal books by absorbing the oil price hike.

Temptation to ease rate may have become a dream
Prior to this recent jump in oil prices, the SBP found itself in a little comfort zone, with inflation starting to descend (10.8%YoY, 8MFY12 compared to 14.1%YoY in 8MFY11). Such was the confidence that the SBP, in its latest published quarterly report for 2QFY12, bloated about not only meeting their full year target of 12% but falling well below it. However if the oil prices continue to rise this attained confidence may well be diluted, and that the SBP’s reaction function is likely to change as well given this uncertainty. Thus in Arif Habib Limited’s opinion this new implied uncertainty may well condemn the SBP to become more reactive, and in current scenario, wait for the fog to dissipate. Therefore, that early temptation to ease the rates, well it might just have become a dream for now!

Bond markets: Not a ‘short’ road to rate hikes
The change in inflation expectations and simultaneously possible rate hike (in the short-term) that may follow have got the bond market all very excited. Yields for shortest tenure have lifted as well as on the long-end of the curve tail, thus giving very prompt indication to SBP of hiking rates pre-emptively. For instance the 10-Yr PIB rate scooped up 15bps, in the last auction to 13.19% and 3-M t-bill was taken by SBP at a rate of 11.82% higher, (almost 11bps short of 1-Yr t-bill at 11.93%). However in Arif Habib Limited’s view this anticipation of a hike by bond markets may have to rest, as SBP waits for reasonable signals to certainty and thus act in a meaningful manner.