• Monetary Board cuts rates by 200bps, setting off an aggressive easing cycle
• Cumulative rate cuts add up to 450bps from June 1; doors remain open for more cuts 
• Expects inflation to further ease in July to 7% from 12% in June and then to low single digits 
• True prices however still remain stickier as traders hold off passing through cost benefits

The Central Bank slashed policy rates again by another 200 basis points yesterday, after delivering a 250 basis point cut in June, amid faster than anticipated deceleration in inflation. Now the Standing Deposit Facility rate stands at 11 percent and the Standing Lending Facility Rate at 12 percent.

“How can you not respond to the sharpest disinflation path we are seeing?,” Central Bank Governor Dr. Nandalal Weerasinghe said in a post meeting monetary policy media briefing held yesterday afternoon in Colombo.   

Sri Lanka’s inflation measured by the Colombo Consumer Price Index, officials’ preferred price gauge, fell sharply in June to 12.0 percent from 25.0 percent through May while the core inflation, which is a better predictor of inflation, fell to 9.8 percent, falling back to single digit levels for the first time since January 2022.

Dr. Weerasinghe said the current monetary policy is the, “most proactive and credible,” both in its way up as well as in its way down. 

The Monetary Board under the Chairmanship of the current Governor was swift in delivering the mega 700-basis point hike in April, last year, the largest in Central Bank’s history, to tamp down the runaway inflationary cycle which was about to get underway after the collapse of the currency.  

With yesterday’s decision, the Central Bank has undone more than half the rate increases since last April by cutting a cumulative 450 basis points in key rates in less than two months, setting off the most aggressive easing cycle to jump start the moribund Sri Lankan economy.

The Central Bank in June surprised the markets by delivering a 250-basis point cut in key rates, ending nearly two-year long tightening cycle, becoming an exception to most of the world’s other central banks, which are still in a tightening mode. 

“The successive reduction in the policy interest rates will provide the impetus for market interest rates to adjust downwards in line with the faster moderation of inflation, so that monetary conditions remain accommodative,” the monetary policy statement released by the Central Bank said yesterday. 

Monetary policy making is premised on inflation targeting and thus a central bank’s job is to tweak the interest rates, its key policy tool, to bring and maintain the inflation at a target or a target range. 

Central Bank said inflation would further soften to 7 percent in July before settling at their target range between 4 to 6 percent thereafter, much earlier than even the Central Bank predicted before.

While the softer inflation readings are welcome and would pave the way for more rate cuts, true prices still remain red-hot as prices of many commodities remain stubbornly stickier. 

This is because manufacturers and traders are reluctant to fully pass down the benefit of the disinflation they see in their supply chains to the end consumer as they hang on to their fatter margins.

While the Monetary Board left open doors for more cuts in rates in the coming months as they shift gears from taming inflation to stimulating the economy, the Central Bank is still a long way from what economists call reaching the ‘goldilocks’ condition – just the right level of rates which are not too low nor too high. 

Monetary Policy making is a tricky balancing act as more easing could overheat an economy while over-tightening could tip the economy into a recession.