KARACHI: In line with expectations, the State Bank of Pakistan (SBP) on Saturday left the benchmark interest rate unchanged at 5.75% for the next two months.

The central bank announces a target rate every two months, which serves as the benchmark interest rate for overnight funds in the interbank market. It is one of the tools the bank uses to ensure price stability in the economy.

A reduction in the target rate poses risk of high inflation, but it also stimulates economic growth by making borrowing cheaper. In contrast, an increase in the target rate restricts the level of liquidity, which subdues consumer prices in the economy.

“The current policy rate of 5.75% and discount rate of 6.25% are likely to remain unchanged till the second quarter (Oct-Dec) of fiscal year 2016-17. However, the SBP may move the interest rate upwards in the third quarter,” Summit Capital Research analyst Chander Kumar predicted in a report on Friday.

The central bank tries to strike a balance by targeting the overnight cost of funds at a level that promotes maximum economic growth without causing high inflation.

In the monetary policy statement, the SBP said year-on-year Consumer Price Index (CPI) inflation rose 3.6% in August 2016 compared to 1.8% in August 2015, while average inflation during the first two months of current fiscal year was more than double the same period last year.

Similarly, core inflation – excluding the volatile food and energy prices – during this period was also higher than last year.

According to the SBP, the expected pickup in domestic demand is largely going to determine the inflation path in the remaining months of FY17.

This is also reflected in the Institute of Business Administration (IBA)-SBP Consumer Confidence Survey of September 2016, which shows improvements in current and expected economic conditions and a major rise in consumer confidence.

However, uncertain global oil prices continue to remain a major determining risk.

The central bank was of the view that liquidity conditions in the money market remained broadly comfortable mainly due to the retirement of government borrowing from scheduled banks.

Resultantly, volatility in the interbank market was low as the overnight money market repo rate mostly stood close to the policy rate.

Thus, it said, the ongoing stability in market interest rates, with weighted average lending rates already at a 12-year low in July 2016, was going to be instrumental at the start of upcoming credit cycle for working capital and also for fixed investment.

“While the global growth outlook for 2016 is subdued, trend in international oil prices remains uncertain,” the SBP said.

“Similarly, anticipation of the impact of interest rate hike by the US Fed, slowdown in the Chinese economy and aftermath of Brexit on international financial and commodity markets is building up on this prevalent uncertainty.”

It pointed out that Pakistan had fared well so far because of a supporting macroeconomic environment and the record high foreign currency reserves had supported stability in the foreign exchange market.

However, “the current account deficit is at the risk of widening further owing to declining exports and rising imports.”

As the China-Pakistan Economic Corridor (CPEC) projects were gathering pace, the SBP expected the economy to expand further on the back of improving industrial activity, especially pertaining to construction and power generation, and rising demand for allied services.

It projected that relatively lower import prices of inputs, low interest rates and better energy supplies would give a boost to the manufacturing sector. An improved security situation would also help in attracting foreign investment, thus adding to the growth sustainability.

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