The State Bank of Pakistan has provided an update on the transmission of monetary policy decisions to financial market and lending rates, noting that the easing cycle that began in June 2024 resulted in a substantial reduction in the policy rate. The central bank said in its latest Monetary Policy Report that the policy rate declined from a recent peak of 22% to 10.5% by December 2025, representing a cumulative reduction of 1,150 basis points over a period of around one and a half years. The reduction was transmitted to market interest rates, with short-term money market rates broadly adjusting in line with movements in the policy rate. Weighted average lending and deposit rates also declined considerably from their recent peak levels during the monetary easing period.
The monetary policy environment changed following the emergence of a supply shock linked to the conflict in the Middle East, which had a significant impact on the inflation outlook. In response to the changing inflation risks, the Monetary Policy Committee increased the policy rate by 100 basis points to 11.5% in late April 2026. The State Bank of Pakistan said the decision was aimed at keeping inflation expectations anchored, containing potential second-round effects and ensuring that inflation returns to its medium-term target range. The initial effects of the policy adjustment have already appeared in financial market rates, with short-term market indicators moving higher following the increase in the policy rate. The central bank noted that these movements demonstrate the early transmission of the monetary policy decision through financial markets.
The overnight repo rate increased to an average of 11.7% following the April policy rate increase. At the same time, its standard deviation declined to 0.25 from 0.39 during February to April 2026, indicating lower volatility and a closer, more stable alignment of short-term market rates with the policy rate. Other market rates also moved upward following the policy adjustment. The Karachi Interbank Offered Rate increased to 12.6% from 11.5%, while the weighted average lending rate rose to an average of 12.9% during May and June 2026, compared with 12.1% during February to April 2026. These changes indicate that the increase in the policy rate has already been reflected in short-term borrowing and lending conditions, although the broader economic impact is expected to take longer to emerge.
The State Bank of Pakistan noted that the full effects of a policy rate adjustment on financing conditions, credit demand, economic output and inflation generally become visible with a lag of around six to eight quarters. While short-term market and lending rates respond relatively quickly to changes in the policy rate, longer-term yields reflect broader market expectations about inflation risks, future interest rates and the likely direction of monetary policy. During the period under review, movements in the yield curve reflected considerable uncertainty caused by the rapidly changing geopolitical situation. Market participants repeatedly reassessed the expected duration and intensity of the supply shock, along with its possible implications for inflation and future monetary policy decisions, resulting in movements in yields across different maturities.
The yield curve subsequently responded to changes in geopolitical conditions during the period. Following the announcement of a ceasefire in mid-June 2026, yields declined across maturities as geopolitical risks and uncertainty eased. However, the subsequent re-escalation of the conflict in early July 2026 resulted in an upward shift in the yield curve. The movement indicated renewed market assessment of inflationary pressures, associated risk premiums and expectations regarding the future path of monetary policy. The State Bank of Pakistan’s assessment shows that the April rate increase has already passed through to several short-term market indicators, while its broader effects on credit demand, economic activity and inflation are expected to emerge over a longer period.
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