SBP Raises Policy Rate to 12% as Inflation Hits 10.3%

ISLAMABAD: The State Bank of Pakistan’s (SBP) Monetary Policy Committee (MPC) has increased the policy rate by 50 basis points to 12%, effective October 27, 2026, citing worsening inflation risks linked to the intensifying Middle East conflict and limited prospects for an early resolution.

Nine of the committee’s 10 members supported the decision. In its monetary policy statement issued on October 26, the MPC said persistently high global energy prices had increased inflationary risks compared with its previous assessment.

The committee said the rate hike was necessary to keep inflation expectations under control, limit the wider effects of supply-side shocks and bring inflation back within the target range of 5–7%. It added that preserving macroeconomic stability was essential for sustainable economic growth.

Inflation Outlook Deteriorates

The MPC identified renewed escalation in the Middle East conflict and disruptions in domestic wheat supplies as key factors keeping inflation high. Their expected continuation over the coming months has further weakened the inflation outlook.

Headline inflation reached 10.3% year-on-year in September, exceeding the committee’s expectations, largely due to higher energy, wheat and related product prices. Core inflation also remained elevated at approximately 8.4%.

The committee cautioned that persistent food and energy price increases could raise inflation expectations and put further upward pressure on core inflation. Other risks include geopolitical tensions, global commodity price fluctuations, unexpected energy tariff adjustments, rising wheat prices and adverse weather conditions.

It stressed that keeping the real policy rate sufficiently positive on a forward-looking basis would help bring inflation within the target range over the medium term.

Economic Activity Shows Gradual Improvement

The MPC reported signs of a gradual economic recovery compared with the fourth quarter of FY26.

Large-scale manufacturing output increased by 1.9% year-on-year during July and August FY27, up from marginal growth of 0.4% in the fourth quarter of FY26. Cement and petroleum product sales, private-sector lending and the Purchasing Managers’ Index also indicated improving economic activity.

The first official estimates for Kharif crops were better than expected, strengthening the outlook for agriculture. Meanwhile, indicators for the services sector—including information and communication technology exports, import volumes and business confidence—also suggested gradual improvement.

The committee maintained its forecast for real GDP growth at 3.5–4.5% during FY27. However, it warned that further escalation of the Middle East conflict and adverse climate conditions associated with worsening El Niño conditions could threaten the outlook.

Current Account Deficit Reaches $874 Million

Pakistan recorded a current account deficit of $874 million during the first quarter of FY27, according to the MPC.

Exports showed signs of recovery, supported by rice, high-value-added textiles and services. Workers’ remittances remained resilient and were expected to exceed earlier projections.

However, imports increased sharply, particularly non-energy imports, reflecting improving economic activity and higher prices.

The MPC expects the current account deficit to remain within its earlier forecast of 0–1% of GDP for FY27. Combined with stronger financial inflows, this is expected to help increase the SBP’s foreign exchange reserves beyond their current level.

The committee said reserves had remained stable at approximately $21.5 billion, equivalent to around three months of import cover, supported by continued foreign exchange purchases. Nevertheless, elevated commodity prices, tighter international financial conditions and supply constraints remain significant risks.

Fiscal Position Remains in Surplus

During the first quarter of FY27, Federal Board of Revenue tax collection rose 7% year-on-year, exceeding the target by Rs33 billion.

Substantial transfers of SBP profits and controlled expenditure helped keep both the overall fiscal balance and the primary balance in surplus during the quarter.

However, the MPC warned that the escalating Middle East conflict had made fiscal management more difficult. It called for continued fiscal discipline, broader tax collection through an expanded tax base and faster implementation of structural reforms.

The committee emphasised that prudent fiscal management remained vital to maintaining economic stability.

Private-Sector Lending Continues to Expand

Broad money (M2) growth increased to 12.7% year-on-year as of October 9, compared with 11.4% on August 28. The increase was driven by stronger net foreign assets growth, supported by rising SBP foreign exchange reserves.

Meanwhile, net domestic asset growth slowed amid fiscal consolidation and increased external financing, reducing the government’s net borrowing from the banking system.

This created additional capacity for banks to lend to businesses and consumers. Private-sector credit grew by 14.1% year-on-year, with lending expanding across working capital, fixed investment and consumer finance.

Textiles, wholesale and retail trade, and agriculture were among the major borrowing sectors. The MPC expects private-sector lending to remain strong as economic activity improves.

Global Inflation Adds to Economic Challenges

The committee noted that major central banks had raised interest rates in response to mounting inflationary pressures, while the International Monetary Fund had revised its global inflation forecasts upward.

It also referred to a staff-level agreement with the IMF and weakening confidence indicators among consumers and businesses. Consumers’ inflation expectations had increased, although businesses’ expectations had declined.

The MPC stressed that Pakistan must strengthen its external and fiscal buffers to withstand increasingly frequent global supply shocks. It reiterated that a prudent combination of monetary and fiscal policies, alongside timely structural reforms, would be essential to achieving stronger and sustainable economic growth.