By: Saad Khan, Arif Habib Ltd.
After posting a single digit growth in Dec-11, we expect the headline inflation to recover its double digit growth momentum from Jan-12 onwards. Our estimates suggest inflation to incur a 1.5% MoM rise during Jan-11 translating into a 10% YoY growth. This will bring the 7MFY12 average inflation at 10.8% YoY much lower than 14.2% YoY in 7MFY11. At these levels the 12 month moving average suggests inflation for FY12 to bottom out at 11.8% YoY which is 20bps lower than SBP’s 12% target rate. Hence in the view of recent developments we have revised down our inflation forecast to 11.6% YoY for FY12 average, compared to 13.7% YoY registered in FY11.
Headline continues to break the food price upside risk
Until recently, we were expecting food prices to show a gradual easing to the end of FY12, which will keep food price relatively sticky for some time. However tracking the 1HFY12 trend we tend to note a sharp deceleration in food prices touching almost 24 month low by Dec-11 at 9.5% YoY. The Sensitive Price Index (SPI) for 1 Quintile showed almost 3% YoY growth in Dec-11, compare this to 21% YoY in the same period last year.
Price adjustments owing to high oil prices is still a base case risk
Currently the Arab Light oil price is trading at USD 109.21/bbl FY12TD close to our initial full year assumption for FY12 at USD 110/bbl. We expect the prices of oil will start to drift lower over the remainder of FY12, as the general trend in futures price dictates. However any sharp upward shift in oil prices will bring our inflation estimates closer to that of State Bank of Pakistan (SBP) target of 12%. We based this in the light of recent government decision to adjust administered prices of electricity, petroleum and gas, in conjunction with higher oil prices.
How well is SBP prepared to deal with any unexpected price shocks?
If oil and food prices were to show a sharp rise, then this would be a temporary shock. A temporary supply shock naturally up ticks the headline inflation in the short-run, contaminating core prices with a lag. In reality, although the food and oil price pressure may seem to have subsided for now but they still remain at elevated levels hence the risk of inflation is clearly tilted to the upside. Previously we argued that the recent rise in non-food prices and sharp exchange rate depreciation is likely to infect the headline inflation going forward. Hence considering this and looking back at SBP performance in dealing with price shock a rate tightening stance cannot be over ruled as yet.
Improving price fundamentals still not enough to call in rate easing
We expect inflation figures to show temporary improvement in the months leading to FY12 end, which might be a welcoming sign considering earlier fears of high inflation year ahead. However, in terms of rate easing, we do not think inflationary figures are at a comfortable level as to reign in any easing stance. Key upcoming triggers to monetary policy decision in our view would be external account data, price behaviour and updates on Pakistan re-entrance into a fresh IMF loan.