Inflation hits 11.1%, policy stays at 11.5%

The State Bank of Pakistan (SBP) kept its policy rate unchanged at 11.5% on Monday, with seven of the 10 members of the Monetary Policy Committee (MPC) voting for the status quo, as intensifying geopolitical tensions pushed up global commodity prices and raised risks to the inflation outlook. Ironically, SBP also claimed that the economy's pace was right and domestic macroeconomic indicators remained broadly in line with its expectations despite a sharp increase in headline inflation, which rose to 11.1% in August from 9.2% in July. The central bank said core inflation was slightly lower than expected, while pressures on the external account remained contained because of robust workers' remittances and higher financial inflows. The MPC also observed that economic activity, after slowing in the fourth quarter of FY26, had started to recover gradually, with recent high-frequency indicators pointing towards an improvement. Against this backdrop, the committee considered the existing monetary policy stance appropriate for bringing inflation towards the 5-7% medium-term target range, although it warned that uncertainty had increased significantly because of the worsening geopolitical environment. The MPC said the recent intensification of the prolonged Middle East conflict had further increased already elevated global commodity prices, while supply chain disruptions continued. The impact was particularly visible in energy and food prices, with higher fuel costs feeding into transportation expenses and subsequently putting pressure on core inflation. Headline inflation accelerated sharply in August, mainly because of food inflation following increases in wheat, allied products and perishable items. Energy inflation also remained elevated amid higher global prices, although the recent change, the MPC claimed, in the high-speed diesel (HSD) pricing mechanism resulted in a sharp reduction in domestic HSD prices during August. The MPC said the reduction partially offset the impact of higher international commodity prices on domestic inflation. However, inflation expectations of both consumers and businesses increased in September, while confidence weakened, adding to concerns over the inflation trajectory. The central bank expects inflation to gradually ease towards the upper end of the 5-7% target range by June 2027, but acknowledged that risks to this outlook had increased significantly. These risks include volatility in global commodity prices, adjustments in electricity and gas tariffs, supply disruptions and unexpected movements in food prices amid worsening El Niño conditions. GDP growth seen at 3.5-4.5% Despite the challenging external environment, the MPC retained its projection for real GDP growth at 3.5-4.5% for FY27. Economic activity moderated during the final quarter of FY26 amid conflict-related disruptions but began recovering in July, according to a range of high-frequency indicators. The central bank cited petroleum product sales, private-sector credit, textile exports and business sentiment as signs of improving activity. Satellite-based indicators, including nighttime lights and gas emissions, also pointed towards a gradual recovery in economic activity during July. Agricultural prospects have also improved, with increased acreage under rice and sugarcane and encouraging initial reports of cotton arrivals. The expected improvement in commodity-producing sectors is likely to support activity in the services sector as well, the MPC said. The recovery in private-sector credit also supports the outlook for economic activity. Private-sector credit grew 13.4% year-on-year, with borrowing increasing across working capital, fixed investment and consumer financing. Wholesale and retail trade, agriculture and sugar emerged as major borrowing sectors. The MPC expects private-sector credit growth to strengthen further as economic activity continues to recover. Reserves cross $21 billion The external sector remained a key area of focus for the MPC, with the central bank saying the July current account deficit was broadly in line with expectations. Imports of goods and services increased faster than exports, although strong workers' remittances helped contain external pressures. The successful issuance of $3 billion in Eurobonds in September, coupled with significant foreign exchange purchases by the SBP, helped lift the central bank's foreign exchange reserves to $21.4 billion. The MPC expects resilient remittances and higher information and communication technology exports to keep the current account deficit within 0-1% of GDP during FY27. Planned financial inflows and continued foreign exchange purchases by the SBP are also expected to meet external financing requirements and support further accumulation of reserves. The central bank expects reserves to approach three months of import cover by the end of June 2027. However, it cautioned that the outlook remains vulnerable to elevated global commodity prices and supply constraints arising from developments in the Middle East. The external account therefore remains one of the key channels through which prolonged geopolitical tensions could affect monetary policy. Fiscal position improves The MPC said fiscal consolidation during FY26 exceeded budgetary targets, mainly because current expenditures remained contained, particularly interest payments. The central bank transferred Rs1.9 trillion to the government during the period, compared with the budgeted amount of Rs1.4 trillion. Despite the improvement, the MPC stressed that achieving the tax revenue target would require sustained efforts amid an uncertain domestic and international environment. It called for faster fiscal reforms, particularly measures to broaden the tax base and reduce losses of public-sector enterprises. Broad money growth slowed to 11.6% year-on-year as of August 28, compared with 13.2% at the time of the previous MPC meeting.