SBP warns of price spirals due to geopolitical developments in Middle East

The State Bank of Pakistan (SBP) has cautioned that geopolitical developments in the Middle East may trigger price spirals globally, impacting macroeconomic projections, according to its biannual Monetary Policy Report (MRR). The report, released on Monday, examined macroeconomic trends and factors that shaped monetary policy since the January Monetary Policy Committee (MPC) meeting.

It underscored the risks posed by climate-related factors like El Nino and floods, which could negatively impact the economy. Additionally, the delay in implementing structural reforms could further hamper exports, hinder productivity gains, and diminish the economy's ability to sustain higher growth without sparking inflation and external account pressures.

Geopolitical tensions in the Middle East, particularly the conflict that erupted in late February, have played a pivotal role in driving upward shifts in global energy prices, freight, insurance costs, and supply chain disruptions. Despite this shock, the macroeconomic outcomes for the fiscal year 2026 (FY26) remained largely on track with the projections outlined after the January MPC meeting.

The SBP's measured monetary policy tightening has been instrumental in taming the ripple effects of the energy price shock while keeping inflation expectations among stakeholders stable. The government's timely increase in domestic fuel prices, along with targeted subsidies and austerity measures, has helped temper aggregate demand and keep demand-side pressures under control.

Inflation is anticipated to ease and stay near the upper boundary of the target range as FY27 concludes. Economic expansion is forecasted to accelerate and persist within the 3.5-4.5% range. The external account deficit is expected to remain within 0-1% of GDP, facilitating ongoing foreign exchange purchases by the SBP and aiding the attainment of the $20.20 billion reserves target by December 2026.

The report also identifies several potential risks to the macroeconomic outlook, encompassing updates on the monetary policy transmission mechanism, the central bank's reaction to supply-driven inflation, varying inflation metrics both globally and domestically, the escalating scale of open market operations and their implications for monetary policy, and the utilization of sentiment surveys to gauge stakeholders' outlook on different facets of the economy.