Mideast tensions cloud SBP rate cut hopes with potential oil price surge

KARACHI: The State Bank of Pakistan (SBP) is poised to announce its interest rate decision later this month, with analysts divided on whether the central bank will cut rates to stimulate growth or maintain policy stability in the face of economic risks.

The ongoing Israeli-Iranian standoff has added complexity to the situation, as a potential spike in global energy prices looms.There will likely be two moves in April and June as the markets anticipate the beginning of monetary easing and an aggressive 400 basis point rate cut this quarter. The central bank has reasons to cut rates given the expected easing of price pressures in the coming months. For the first time in almost three years, real interest rates turned positive in March.

But the Iranian drone assaults on Israel over the weekend have signaled the start of a new, and far more dangerous era in the Middle East's problems. The main threats to the world economy are whether this now turns into a larger regional conflict and how the energy markets react.

As an oil-importing country, Pakistan can be impacted by the rise in oil prices, particularly in light of the precarious balance of payments. This would discourage betting on rate cuts and force the SBP to remain cautious, maintaining record-high borrowing costs at the meeting on April 29 and in some reviews that follow.

The SBP kept its benchmark interest rate unchanged at 22 percent since July 2023. The central bank has hiked interest rates by a cumulative 15 percentage points since September 2021 to combat soaring inflation.

Oil prices fell on Monday, trading at $89.64 a barrel after Iran declared that it no longer saw its retaliation against Israel as warranted, although the Israeli response is yet uncertain.

“Yes, an increase in geopolitical tensions between Iran and Israel is very likely to result in higher oil prices at least in the near term which will hurt Pakistan's economy in the form of higher cost of supply translating into higher local fuel prices,” said Mustafa Mustansir, the head of research at Taurus Securities.

Over the last three months, there has been a considerable increase in global oil prices in particular Arab Light Crude which is currently trading at around $92 a barrel, he said.

“The SBP in its latest monetary policy did mention the point of increasing oil prices due to tensions in the Middle East plus it also flagged a further increase in 'administered energy prices' as a risk to the near-term and medium-term inflation outlook,” Mustansir added.

“If the situation worsens i.e. current forward inflation expectations change substantially due to higher oil prices, we may see the commencement of monetary easing being delayed.”

It should also be noted that fuel prices have a secondary effect on other items ofthe consumer price index (CPI) too i.e. food mainly due to an increase in transportation costs, and also on core segments. Hence, the overall impact on CPI is bigger and longer than simply looking at the change in the transport index, according to Mustansir.

These second-round effects cannot be ignored unless they are deemed insignificant, he noted.The CPI inflation eased to 20.68 percent in March from 23.6 percent in the previous month.The SBP increased its average inflation forecast for the current fiscal year to 23–25 percent from a previous projection of 20–22 percent in January because of growing gas and electricity prices.

The World Bank projects that inflation will average 26 percent in the current fiscal year, then drop to 15 percent in the next year and 11.5 percent in 2026.

In order to hold talks over a new International Monetary Fund programme, the Finance Minister and his colleagues have left for Washington. These kinds of talks are especially important during these unstable times since they could help to stabilise the economy.

At the same time, Pakistan is ready for a major diplomatic visit by the Saudi Foreign Minister and his delegation. The impoverished nation of Pakistan is in dire need of the $5 billion investment package that Saudi Arabia and Pakistan agreed to expedite last week to support its current account deficit and demonstrate to the IMF that it can continue to meet the demands for foreign financing, which have been a major requirement in past bailout packages.

“We need to keep in mind that oil prices were incorporating this war/attack and oil prices went up during the last 2-3 weeks. Also with weak data from China and Europe alongside the US presidential election this year, we don't foresee oil prices going higher,” said Tahir Abbas, the head of research at Arif Habib Limited.

“We estimate that for every $5 per barrel change in oil prices, Pakistan's current account will change by $1 per barrel on an annualised basis,” Abbas added.“I believe that the majority of the consensus of inflation is from 12-16 percent for FY25 and it won't change drastically assuming oil prices will come down (75-80/bbl.) in the midterm,” he said.

“On interest rates, I think it's a split between April and June as investors are thinking that interest rates might come down after the finalisation of the new IMF programme,” he said.“However, I do believe that SBP may start a rate cut from April (token 50-100 bps) to give markets a signal as we are now having real positive rate on a current month basis and more importantly NFNE [non-food non-energy] is also on a declining trajectory.”