• But rules out further easing due to potential excesses emerging in economy
• Beginning of current easing cycle dates back to May in 2019 but grew in intensity in 2020
• Says gradual recovery in economy and rising inflation expectations could drive treasury yields higher

The Central Bank could stay on its current dovish monetary policy path through the rest the year, as the desired goals of such a policy are being achieved by way of accelerated pace of credit to the economy, although further easing is ruled out due to the potential excesses emerging in the economy. 

According to ICRA Lanka, which took a view on the future path of the interest rates in the economy, “it is very likely” that the current monetary policy to continue through the second half but denied of further scope for any more policy easing, due to the external sector vulnerabilities and expected rise in inflation.

At its fifth Monetary Policy review held on July 8, the Monetary Board took note of the spike in food inflation, caused by the supply-side disruptions and said it wouldn’t be shy to intervene if it sees any signs of persistent pressures in the prices.

The private sector credit accelerated in June, defying the more moderate expectations, signalling that such credit is on track to meet its desired year-end targets while the Colombo inflation too accelerated to 5.7 percent in July, from 12 months ago, closing in on the upper bound of the Central Bank’s desired inflation range set at 6.0 percent.     
“On the other hand, the CBSL has emphasised its commitment to keep interest rates at single digits. Hence, it is very likely that the CBSL will maintain its current policy window through 2H,” the rating agency said in its outlook for the second half, as part of its customary 
mid-year economic update.

The beginning of the current easing cycle dates back to May in 2019 but grew in intensity in 2020, when the monetary policy was required to provide extensive support to blunt the impacts and provide stimulus to reboot the economy stung by the virus. 

This makes this current cycle the longest, deepest and most effective in transmission into the real economy, yielding its 
desired outcomes.  

The Monetary Board hasn’t signalled a change to its current course and ICRA Lanka’s expectation would further reassure markets of the policy continuity, a hallmark of this government’s broader tax and money policies, which provide predictability to the economic actors, who plan ahead.  

However, the rating agency said the gradual recovery in the economy and rising inflation expectations could drive treasury yields higher, which would resist the downward adjustment in the market lending rates in the medium term, which descended to their lowest levels in the history. 

It’s natural for the prices to inch a bit higher when growth becomes the target but the challenge for the Central Bank is to maintain the interest rates at levels, which neither overheat the economy nor derail the economic growth—a delicate balance any central bank in the world struggles to maintain for a sustained period. 

“We feel, T-bills may potentially move up by another 10-20 bps in 2H. Therefore, we expect the AWPR to fluctuate in a relatively broader range between 5.50 to 6.50 percent for the rest of the year,” ICRA Lanka added.