Pakistan's central bank kept its key interest rate steady for the third time but said the domestic economic recovery had gained further traction and while its rate will remain unchanged "in the near term" it is starting to look toward reaching "mildly positive real interest rates" as the economic recovery becomes more durable and the economy returns to full capacity.
The State Bank of Pakistan (SBP) left its monetary policy rate at 7.0 percent, unchanged since it was last cut in June 2020.
"Most economic activity data and indicators of consumer and business sentiment have show continued improvement," SBP said, adding there were now upside risks to its current forecast for growth in fiscal 2021, which began July 1 last year.
As other central banks, SBP began easing its monetary policy stance sharply in March last year in response to the COVID-19 pandemic and cut it 5 times by a total 625 basis points from March to June.
Prior to the COVID-19 crises, SBP had been on a tightening path, raising the rate 7 times and by a total of 725 basis points from May 2018 to July 2019.
"With the inflation outlook relatively benign aside from the possibility of temporary supply-side shocks, the MPC felt that the existing accommodative stance of monetary policy remained appropriate to support the nascent recovery while keeping inflation expectations well-anchored and maintaining financial stability," SBP said.
After contracting sharply from March to June last year, Pakistan's large-scale manufacturing sector returned to expansion in July and SBP said this recovery had strengthened in recent months, with LSM output up 7.4 percent year-on-year in October and 14.5 percent in November.
So far in the current fiscal year, LSM has grown an annual 7.4 percent compared with a contraction of 5.3 percent in the same period last year. However, the level of manufacturing activity is still below average levels seen in FY19, pointing to continued spare capacity in the economy.
Pakistan's inflation rate eased to 8.0 percent in December from 8.35 percent in November and SBP confirmed it still expects inflation to fall within its expected range of 7-9 percent for FY21 and trend toward its 5-7 percent target range over the medium term.
Although utility tariff increases may cause an uptick in inflation, SBP said this was likely transient given the excess capacity in the economy and well-anchored inflation expectations.
But amid the favorable outlook, the central bank stressed the trajectory of COVID-19 is difficult to predict given the still-elevated global cases, the emergence of new strains and uncertainties about the roll-out of vaccines worldwide.
"In light of such Covid-related uncertainties, the MPC considered its appropriate to provide some forward guidance on monetary policy to facilitate policy predictability and decisions-making by economic agents," the bank's monetary policy committee said.
Most major central banks, such as the U.S. Federal Reserve and the Bank of Japan, use forward guidance to signal the expected path of interest rates to help guide the financial decisions by businesses, households and financial markets.
Forward guidance was first used during the Global Financial Crises to calm financial markets and investors and has increasingly been adopted by central banks worldwide as part of their tool kit.
It appears to be the first time Pakistan's central bank has adopted forward guidance.
"In the absence of unforeseen developments, the MPC expects monetary policy settings to remain unchanged in the near term. As the recovery becomes more durable and the economy returns to full capacity, the MPC expects any adjustments in the policy rate to be measured and gradual to achieve mildly positive real interest rates," SBP said.
