Pakistan central bank seen cutting rates to single digits

Pakistan’s central bank is expected to cut interest rates sharply later this month, potentially bringing the policy rate back into single-digit territory for the first time in nearly four years, according to a report by brokerage firm Arif Habib Ltd.

The State Bank of Pakistan is likely to reduce the policy rate by 75 basis points at its next monetary policy meeting on Jan. 26, taking the benchmark rate to 9.75%, the report said.

If implemented, the cut would take interest rates to their lowest level in nearly four years. In the bond market, cut-off yields on three- and six-month treasury bills have already fallen into single-digit territory for the first time in almost 4.5 years, while the one-year bill has hovered around the 10% level.

Cumulatively over the last two treasury bill auctions, yields declined by 59 basis points on one-month bills, 59 basis points on three-month bills, 53 basis points on six-month bills and 49 basis points on 12-month bills.

“Nearly four years after rates last dipped below 10%, the idea of a single-digit policy rate is moving from a historical reference into the present debate,” Arif Habib Ltd. said.

According to WE Financial Services, after years of monetary tightening, the return to single-digit interest rates would mark a significant shift toward supporting growth.

However, it expects a 50bps rate cut in the upcoming monetary policy announcement, bringing the policy rate to 10%. It said its survey aligned with this view, reinforcing expectations of a dovish stance in the upcoming MPS.

A majority (57.1%) anticipate a 50bps cut, while 28.6% expect a deeper 75bps reduction and 14.3% foresee a modest 25bps move, said the brokerage house.

Inflation and macro backdrop

The brokerage said the expected cut is supported by a sharp slowdown in inflation, a stable currency, manageable external accounts and easing global commodity prices, particularly oil. It added that domestic demand and industrial activity are also showing signs of recovery, creating room for monetary easing without destabilising the economy.

Headline inflation has settled within the SBP’s medium-term target range of 5% to 7%, the report said. Average inflation in the first half of fiscal year 2026 stood at 5.11%, down from 7.29% a year earlier, while core inflation eased to 7.4% from 10.93%.

Arif Habib Ltd. flagged risks including seasonal price pressures during Ramadan and Eid, potential base effects later in the fiscal year, and ongoing geopolitical uncertainty. However, it said the broader inflation trend remains favourable.

The firm expects inflation to average 8.04% in the second half of FY26, bringing the full-year average to 6.7%, comfortably within the central bank’s target range.

Bond market signals

Bond market movements also point to an imminent rate cut, the report said. Treasury bill yields have fallen sharply across all maturities, with single-digit cut-off yields returning in the three- and six-month tenors for the first time since November 2021.

“The bond market is now confirming what inflation data has been signaling,” the report said, adding that investors have positioned for policy easing ahead of the central bank’s decision.

While a 75-basis-point cut appears most likely, Arif Habib Ltd. said conditions could allow for a larger reduction if economic stability continues.

“If confidence remains intact, the space for a slightly bolder move quietly exists,” the report said.