CB likely to hold policy rates on Thursday

With the economic activities and credit growth picking up pace, the Monetary Board of the Central Bank (CB) is likely to hold its key policy rates steady at their current levels, according to First Capital Research (FCR).

“While a hike is off the table, due to the lacklustre economic growth, we believe that there is a 70 percent probability to hold rates, due to the considerable improvement in high frequency indicators and with fiscal and monetary measures implemented so far. 

However, there is a 15 percent probability each for 25bps and 50bps rate cut to support economic growth,” FCR said in its pre-policy analysis report released yesterday.

The CB is scheduled to announce the second monetary policy review for this year, Thursday morning. 

FCR pointed out that there’s been a considerable improvement in high frequency indicators such as LMDNielsen Business Confidence Index (BCI), Index of Industrial Production (IIP) and Manufacturing and Service Purchasing Managers’ Index (PMI).

“New business activity in PMI increased in January 2021, particularly with the improvements observed in financial services, transportation and wholesale and retail trade sub-sectors,” it highlighted.

Meanwhile, the private sector credit in January rose by Rs.25.7 billion, recording a six-month growth streak, indicating that businesses and individuals are speeding up their economic activities.

In order to maintain liquidity and support government finances, the CB has infused ample liquidity into the banking system through money printing.

The CB’s holdings of government securities increased to a record Rs.809.9 billion as of 26th of last month, from Rs.738.4 billion at the end of last year.

However, FCR noted that growth remains a concern for the CB, as the government expects a full rebound in economic activities, targeting 5.5-6 percent economic growth this year, from an estimated contraction of 3.9 percent in 2020. 

FCR forecasted Sri Lanka’s economy to grow by 3.2 percent this year, from an estimated 5.8 percent contraction in 2020.

“Lack of demand for credit, slowness in consumer demand recovery and import restrictions can be considered as a major factor favouring to ease the policy rates at the upcoming meeting,” FCR noted.

In addition, FCR opined that a rate cut would be essential to sustain the secondary market interest rates at current lower levels.
The government is largely relying on domestic debt instruments to finance its budget shortfalls in taking advantage of the low interest rate regime, while foreign debt has become expensive amid credit ratings downgrades.

However, treasury yields spiked recently on the back of auction undersubscriptions.

“The last two bond auctions and five bill auctions were undersubscribed by a considerable amount, reflecting the lack of clarity among market participants with the current economic condition,” it noted.

Hence, FCR noted that this could trigger the CB to consider a possible rate cut on Thursday.