Following the release of the latest data on inflation that put the consumer price index (CPI) at 3.96% for November on a year-on-year basis, the equity market now expects the central bank to slash the key interest rate in the economy by as much as 1%.
“Considering lower-than-anticipated inflation, falling oil prices and expected dollar inflows from Sukuk and the International Monetary Fund (IMF), we expect the policy rate to go down by 50 to 100 basis points in 2015,” Topline Securities said in its commentary on inflation data.
CPI is calculated every month on the basis of price movements of 481 commodities. As far as raw data is concerned, year-on-year inflation marked an 11-year-low in November. However, the CPI was re-based during the last decade and 2007-08 was used as the base year for the latest CPI reading.
After a gap of one year, the SBP brought down the discount rate by 0.5% to 9.5% last month. It is the interest rate at which commercial banks are allowed to borrow from the central bank’s discount window on an overnight basis.
After accounting for the November reading, the average inflation in Pakistan since July clocks up at 6.45%. This means the inflation-adjusted interest rate, or real interest rate, in the economy is currently hovering around 300 basis points.
According to Global Securities, inflation-adjusted inflation rates in the last three years have averaged around 1.78%. The widening gap between the inflation rate and discount rate suggests that the SBP may opt for a downward revision in its monetary policy announcement next month.
“With falling returns on government papers and national saving schemes, we expect more cash flows from institutions and high net worth individuals towards equities. We maintain our positive stance on the (equity) market,” Topline Securities said.
Global Securities also expects a cut of 50 to 100 basis points in the discount rate, as it estimates inflation in December-January to remain between 5% and 6%. Similarly, BMA Capital believes expanding real interest rates will lead to further monetary easing by the SBP.
KASB Securities, Taurus Securities, JS Global Capital, Invest Capital Markets and WE Financial Services also issued separate research notes on Tuesday that predict a cut of up to 100 basis points in the key interest rate.
They have advised their clients to invest in cement and textile stocks, which represent sectors of the economy that are highly leveraged and will benefit directly from a downward revision in the interest rate.
Published in The Express Tribune, December 3rd, 2014.
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