Inflationary signs

Post-Eid ease in food prices checked the August inflation as CPI declined by 0.3 percent on monthly basis to bring down the yearly increase to 3.6 percent as compared to 4.1 percent in the previous month. Nonetheless, the dent on the base due to1.3 percent monthly inflation in July has shown its strain in August numbers.

Headline inflation in the both two months of FY17 is higher than average inflation of 2.9 percent in FY16. And it’s likely to pick up further in months to come. Anyways, assuming oil prices not to take a steep upward shift, inflation is likely to stay in the band of 3-6 percent for remaining 10 months of the fiscal, while the full year average may remain between 4-5 percent.

It’s no brainier to correlate the low inflation with falling oil and other commodity prices. In Jan-Jun 14, inflation averaged at 8.4 percent; ever since then, it has nosedived to follow oil prices dip. Twelve-month CPI moving average was 8.6 percent in Jul14, and it bottomed out at 2.6 percent in Feb16, which was exactly the time frame when oil prices hit the trough.

WTI prices averaged from their lows of $30.4 in Feb, have reached $44.7 in July. The 12-month moving average of inflation moved in tandem with the oil prices (see graph). The fall in inflation is lagged by a few months; and based on this simple arithmetic the inflation is likely to pick up in the coming months.

However, Dar and team are trying to arrest the trend by not passing on the impact of higher oil prices to consumers via increased fuel prices. Within the inflation basket, transportation index dragged other goods and services, especially food prices down in the last two years (see graph 2 for 12-month moving averages). Lately, the upward movement in oil prices has not been transmitted to fuel prices, so the transportation index has not moved up in line with oil prices.

The heavy weight food prices were also on a steep southward journey in the last two years. Agriculture product prices usually move in cycles, and right now the index trying to find its way up from rock bottom. There is an upward trend visible in cotton prices, and the day may be not far when the wheat, rice, sugar and other food crops prices also start moving up.

Thus, its high likely that food and transportation prices would go up in FY17; and with time, prices in virtually all goods and services may start heading north.

However, the second largest group in CPI basket - housing and utilities did not fall too much during the time of low commodity prices as it’s 12 month moving average moved down from the peak of 9.1 percent (Oct 14) to 5.1 percent today. The reason is simple - real estate prices sky rocketed in the last two years in Pakistan. But the rental prices have not moved (at least in PBS records) anywhere close to the pace of real estate prices.

Thus, the rental prices might be close to their bottom as well. The bottom line is that inflation is ought to be in pressure; and this is evident from demand side as well. The monetary assets grew, and picked up a little from 13.2 percent (FY15) to 13.7 percent in FY16.

There is a fear that the note printing machine might be in action again - this fiscal year so far, government borrowing from SBP in cash basis up is by Rs930 billion. There is an act that bounds borrowing from SBP to be net zero on quarter end. But since there is no IMF to check now, let’s see how brave Dar is in handling it. Whatever he does, inflation is likely to inch up and what SBP should do to not ease monetary policy any further.