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Morning Call about Inflation preview – Arif Habib Limited

Karachi: CPI dips below expectations at 10.19% YoY, not reigning in a rate cut scenario

Nov’11 CPI inflation, at 10.19%YoY (compared to 10.96%YoY last month), was well below expectations (Arif Habib Limited and consensus-carried out by Bloomberg had forecast 10.7%YoY), keeping the 12MMA rate just about 40bps above SBP target of 12%YoY (FY12-average). In particular, low food price (SPI up by +~3.8% YoY in Nov’11, compared to +~22.5% YoY in Nov’10) and seasonally normal behaviour of non-food price led to a tame headline figure. Looking at the monthly analysis the headline posted a 0.3% MoM rise, with core (non-food non-energy, Trimmed) at 0.6% and 0.4% MoM, respectively. The relative stickiness of core prices is expected to gradually pace up, in the coming months ahead, something to watch out for, in Arif Habib Limited’s view.

Clearing way for the non-food prices
So far Arif Habib Limited has argued that the current level of inflation is not being driven by the food component alone. While the rise in food prices in FY11 was apparently the result of severe weather conditions both in domestic and international front, a persistent upturn in energy prices, has also resulted in inflationary pressures domestically. The NFNE core inflation has continuously registered double digit YoY growth in since Jul’11 averaging ~10.24%YoY, 5MFY12. Excluding the food and energy price this rise in Arif Habib Limited’s view is attributed rising financing demand of government for budgetary purposes which to date stands at PKR 632bn (~97% YoY rise in stock). Furthermore, expected upward adjustments in electricity tariffs, and potentially higher imported inflation as well as a substantial rise in public sector borrowing requirements, albeit will results in persistent inflationary pressure going forward.

Accentuating the currency slide
Although the easing inflationary concerns and to a lesser extent exchange depreciation (USD/PKR 89.40 as of 2nd Dec’11, ~3.9% FY12TD) has aided in the current easing cycle (ex-Nov’11 MPS), Arif Habib Limited thinks SBP focus will likely shift towards containing upside risks to inflation from both supply and demand-side factors going forward. Commodity price (in particular that of crude oil) trends pose a risk to inflationary pressures for FY12, in Arif Habib Limited’s view. Indeed, it is worth noting that 4MFY12 import bill has picked up considerably to ~23% YoY, a further rate easing will likely cause a sharp PKR depreciation, a recipe for imported inflationary impact going forward. A road, less likely SBP is going adopt.

Gradual recovery to rate easing
Looking at the inflation ahead, Arif Habib Limited thinks there is no strong signalling of rate easing in the upcoming MPS Jan’12E. However beyond FY12, Arif Habib Limited thinks sustained price pressures, relatively weak external accounts and gradual recovery in credit to private sector pick-ups may lure SBP to deliver a rate cut prior to Jun’12E. Arif Habib Limited is keeping Arif Habib Limited’s inflation projections unchanged at 12.4% YoY by the fiscal year end, on the back of fading base effects, sticky core prices, and non-administrative price push.

Why change the policy rate at all in 2HFY12?
That in Arif Habib Limited’s view depends, on the realisation of headline inflation trend alongwith the pace of recovery in external accounts, but Arif Habib Limited’s feeling is that the SBP may keep the easing bias for some time. Taking the recent rate pause (Nov’11, MPS rate unchanged at 12%), the SBP highlighted sticky prices, weak growth confidence and a gradual easing in private credit conditions, which pretty much was in line with ours and market consensus. While looking ahead, SBP’s forecasts for inflation look similar to ours and consensus (albeit slightly lower). But beyond FY12, Arif Habib Limited’s forecasts for inflation are considerably higher (11.3% YoYE) and so does SBP recent talk-terms suggest a retreatment from its initial stance of achieving a single digit inflation target (9%YoY FY13). Thus in Arif Habib Limited’s opinion a rate easing in 2HFY12 if followed, would come more of a short-sighted bias, and should be viewed as a rate cut hiccup.

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