Middle East conflict, higher energy costs and wheat disruptions worsen inflation outlook
KARACHI:
The State Bank of Pakistan (SBP) raised its policy rate by 50 basis points to 12% on Monday, as escalating conflict in the Middle East, elevated energy prices and domestic wheat supply disruptions worsened the inflation outlook, prompting the central bank to tighten monetary policy despite a gradual economic recovery.
The Monetary Policy Committee (MPC) approved the increase by a majority of nine out of 10 members, with the new rate taking effect from October 27, 2026. The MPC said the decision was necessary to anchor inflation expectations, prevent a supply-side shock from feeding into broader prices and bring inflation within the target range of 5% to 7%.
The latest increase follows mounting global inflationary pressures as the Middle East conflict intensifies and prospects for a near-term resolution remain limited.
The SBP said the domestic impact of the external shock had remained contained so far, supported by proactive monetary policy adjustments and continued fiscal discipline, but risks to the inflation outlook had increased.
The decision also reflects a shift in the inflation assessment since the previous monetary policy meeting, even as the outlook for economic growth and the external account remained broadly unchanged.
Consumer inflation accelerated to 10.3% year-on-year in September, exceeding the MPC’s expectations, as higher energy and wheat prices contributed significantly to the increase. Core inflation also remained elevated at around 8.4%.
The MPC identified the renewed escalation of the Middle East conflict and domestic wheat supply disruptions as the two principal factors keeping inflation high. Their expected persistence over the coming months has further clouded the outlook.
The SBP warned that sustained food and energy price increases could raise inflation expectations and eventually feed into core inflation. Other risks include global commodity price volatility, unexpected adjustments in energy tariffs, further increases in wheat and related products, and adverse weather conditions.
Ironically, despite mounting price pressures, the committee said economic activity had begun recovering gradually from the fourth quarter of fiscal year 2026. Large-scale manufacturing (LSM) output grew 1.9% year-on-year during July-August FY27, compared with marginal growth of 0.4% in the fourth quarter of FY26.
Other indicators, including cement and petroleum, oil and lubricant (POL) sales, private-sector credit and the Purchasing Managers Index, also pointed towards improving economic activity. Satellite imagery tracking nighttime lights and nitrogen dioxide emissions supported the assessment.
The outlook for agriculture improved after initial official estimates of Kharif crops proved better than anticipated. Indicators for the services sector, including information and communication technology exports, import volumes and business confidence, also suggested gradually improving prospects.
The MPC maintained its projection for real GDP growth at 3.5% to 4.5% for FY27. However, it cautioned that further escalation in the Middle East conflict and adverse climate events amid worsening El Nino conditions could undermine the recovery.
Pakistan recorded a current account deficit of $874 million during the first quarter of FY27 as imports increased alongside the recovery in domestic activity and higher prices.
Exports showed signs of recovery, led by rice, high-value-added textiles and services. Workers’ remittances remained resilient and were projected to exceed the central bank’s earlier assessment.
However, rising non-energy imports added pressure to the external account. The MPC expects the full-year current account deficit to remain within its earlier projected range of zero to 1% of gross domestic product.
The committee said this outcome, together with higher financial inflows, should help increase the SBP’s foreign exchange reserves beyond their current level.
The central bank’s reserves remained stable at around $21.5 billion, equivalent to approximately three months of import cover, supported by continued foreign exchange purchases. The MPC nevertheless flagged elevated global commodity prices, tighter international financial conditions and supply constraints as risks to the external outlook.
It also noted that Pakistan had reached a staff-level agreement with the International Monetary Fund (IMF), while the Fund had revised its global inflation projections upwards. The Federal Board of Revenue (FBR) collected 7% more taxes year-on-year during the first quarter of FY27, exceeding its target by Rs33 billion.
Supported by a substantial transfer of SBP profits and contained expenditure, the overall fiscal and primary balances were assessed to have remained in surplus during the quarter. However, the committee warned that higher global energy prices and the intensifying Middle East conflict had made fiscal management more challenging.
Broad money (M2) growth accelerated to 12.7% year-on-year as of October 9, compared with 11.4% on August 28, largely because rising foreign exchange reserves accelerated growth in net foreign assets.
Meanwhile, growth in net domestic assets slowed amid continued fiscal consolidation and higher external financing, reducing the government’s net budgetary borrowing from the banking system. This created room for lending to businesses and households.
Private-sector credit grew 14.1% year-on-year, with expansion spread across working capital, fixed investment and consumer financing. Textiles, wholesale and retail trade, and agriculture were among the main borrowing sectors.
The MPC expects private-sector credit to maintain its momentum alongside the projected recovery in economic activity.
