PAKISTAN: SBP ends easing cycle, holds key rate at 12.0%

• SBP cited sticky core inflation, reemergence of external sector pressure for the decision
• Headline inflation seen easing further before inching up
• GDP growth forecast kept at 2.5%-3.5% for FY25
• Forex reserves likely to surpass USD 13bn by June due to lower debt repayment, higher loan inflows

The State Bank of Pakistan (SBP) on Monday left the policy rate unchanged at 12.0%, it said in a statement. The decision was unexpected as most economists polled by Reuters and Bloomberg had predicted a 50bps cut. While acknowledging lower-than-expected inflation in February, the central bank said that volatility in food prices, sticky core inflation and reemergence of external account pressures warranted a status quo on its key rate. It deemed the current real interest rate "adequately positive" to sustain the ongoing macroeconomic stability.

CPI inflation eased to 1.5% y/y in February, the lowest since Sep 2015, driven mainly by a decline in food cost, reflecting sufficient farm supplies. However, underlying price pressures remain elevated, with core inflation (in rural areas) sustaining double-digit growth. The SBP projected headline inflation to moderate further before gradually inching up and stabilizing within the target range of 5%-7%.

Notwithstanding the continued contraction in manufacturing output, the SBP remained upbeat about growth, citing improvement in high-frequency indicators and subsiding downside risks to Rabi crops. It forecast economic activity to gain further traction during Jan-Jun period, supported by easing financial conditions, noting that the impact of sizable earlier reduction in policy rate is now materializing. GDP growth forecast was kept unchanged at 2.5%-3.5% for FY25, which is aligned with the IMF's January growth projection of 3.0%. The economy grew 0.9% y/y in Q1 (Jul-Sep) of the ongoing fiscal year.

On the external front, the SBP maintained its forecast of current account balance at a surplus and a deficit of 0.5% of GDP for FY25, despite flagging rising imports. A USD 0.4bn current account deficit in January - following months of surplus - was attributed to increased import volume and an uptick in global commodity prices. However, robust workers' remittances and relatively moderate export growth helped contain the deficit. Moreover, the central bank expected its foreign exchange reserves to surpass USD 13bn by June, from USD 11.25bn as of Feb. 28, due to lower debt repayments and expected realization of planned official inflows.

The decision marks the end of the SBP's easing cycle, which saw a 1,000bps cut in the key rate since June 2024 from an all-time high of 22.0%. It comes as an IMF mission is currently in Pakistan to hold the first review of the USD 7bn Extended Fund Facility. The lender has urged the central bank to pursue a tight monetary policy stance. A successful review would unlock the second tranche of USD 1bn for the country. Besides aiding growth, the sharp decline in the benchmark interest rates has reduced the government's borrowing cost, thereby helping it meet its fiscal deficit target.