CB could pause turning hawkish as virus remains hangover on economy

• FCR assigns 90% probability for current rates to continue
• Many central banks elsewhere have dialed back their pandemic era monetary policy support by way of rate hikes

Although most central banks around the world are ending their virus era policy support measures and turning hawkish, Sri Lanka might not go along with them in lockstep as the pandemic continues to batter the country’s economic recovery, making a case for a further policy support, according to First Capital Research (FCR). 

Releasing their customary pre-policy analysis ahead of today’s (August 18) monetary policy meeting, the research firm said any inclination towards a tightening stance could see a delay as the Central Bank could practice little patience in keeping interest rates at current levels. 

In July, FCR expected an increasing probability for a rate hike, towards the 2H21 to blunt any risk of overheating from more than a yearlong monetary and fiscal stimulus. While that stance remains, their majority probability for the rest of the year is to maintain the rates at current levels. 

“We believe that CBSL may consider maintaining the same policy stance in this policy review as well but given the considerable improvement in high frequency indicators to prevent an overheating of the economy, there is a considerably low probability that CBSL is likely to hike its policy rates,” FCR said assigning a 90 percent probability for current rates to continue and 10 percent probability for a 25 basis points hike in policy rates considering high inflation, pressure on exchange rate and the yields on government securities. 

Many other central banks elsewhere in the world have dialed back their pandemic era monetary policy support by way of rate hikes during the last few months despite the surge in the Delta variant. 

The United States Federal Reserve (Fed), the mostly watched central bank in the world for policy cues, has also begun debating about when and how to slow their its purchasing programme, which is referred to as ‘qualitative easing,’ (QE) before starting hiking rates. 

Analysts expect the 13-year high inflation of 5.4 percent stayed through July in the US could also put pressure on the Fed to roll back QE and start raising interest rates sooner than expected. 

A similar scenario is also unfolding in Sri Lanka where the Colombo inflation rose by 5.7 percent in July from a year ago, urging the Central Bank to act fast to arrest the fast ascent seen in the prices. However the recent spike in inflation is said to be caused more by the supply side constraints than demand side pressures.

Therefore if the current bout of inflation proves transitory, concerns over prices could be dealt without any adjustment to the current monetary policy stance. 

However, the Central Bank has also maintained they stand ready to act should high inflation appears more persistent. 

However, what could be more compelling for the Monetary Board to remain dovish at its coming policy meeting is the lingering effects of the virus weighing on the economy, a stance which was also reinforced by ICRA Lanka in a report this week.  

Meanwhile, FCR also believes that the improvement in high frequency indicators such as the growth in private credit which rose by a robust 13.3 percent in June from a year ago could also prompt the Monetary Board to maintain policy rates, in a bid to further channel low cost funds into the real economy, which in turn will prop up economic activities.  “Since government’s main objective is to enable low-cost credit to the economy thus supporting the revival of economic activities, changes to prevailing easing monetary policy is unlikely,” they added. 

ICRA Lanka however said the lingering virus could have a bearing on both demand and supply sides of private sector credit as banks would turn more cautious while borrowers could see only little incentive in investments when the economy is at sub-dormancy levels.