Central Bank likely to maintain current interest rates on Thursday to support pandemic-hit economy

The Monetary Board is likely to maintain the current low interest rates at its upcoming Monetary Policy meeting to provide further support to the economy, which was knocked off course by the third wave of the pandemic, although any moves beyond that would tilt towards tightening the policies to prevent possible overheating, according to First Capital Research. 

The Monetary Board is meeting this evening (7th) for the fifth time for the year to determine the trajectory of the interest rates and the possible need for more stimulus as the economy was just coming off from a two month long restrictions that stood on swaths of businesses and livelihoods. 

There is a greater chance for the Board to leave the benchmark interest rates at the prevailing levels— Standing Deposit Facility Rate at 4.50 percent and Standing Lending Facility Rate at 5.50 percent—as there is a consensus that the economy would require further stimulus to run its full course to recovery and reach its Goldilocks zone. 
“We believe that CBSL may consider to maintain the same policy stance in this policy review as well, but given the concerns around economic uncertainty and considerable improvement in high frequency indicators to prevent an overheating of economy, there is considerably low probability that CBSL is likely to hike its policy rates,” First Capital Research said in their customary pre-policy analysis ahead of tomorrow’s official policy statement. 

As the third wave of the pandemic took hold since mid-April, there was an expectation by certain sections that the current low interest rates would stay longer than anticipated earlier because the government will have to lean heavily on Central Bank liquidity to bridge the expanding budget gap, caused predominantly by the lost tax incomes during the second quarter.

And for that to happen the interest rates have to stay low, so that the government could borrow at low rates.  
The past monetary policy actions have already taken root in the real economy as seen from the continuous recovery in private sector credit and other high frequency indicators which have also responded positively in tandem, reflecting that current policies are working efficiently, though the recent slowdown was caused due to fresh restrictions.  

While there is a greater consensus on the rates to remain where they are now through the end of the year, whatever their next move is increasingly bent towards a hawkish stance where the Monetary Board could begin to scale down their stimulus to prevent the economy from overheating. 

Globally, too, central banks are beginning to dial back on their excessive monetary stimulus deployed to confront pandemic induced economic challenges, through 2022 and there is a wider expectation that Sri Lanka would too tread towards there in lockstep from the beginning of next year. 

“Towards the 2H2021E, we expect a continued increase in probability for a rate hike in order to prevent overheating of the economy amidst the given fiscal and monetary stimulus. However, probability for maintaining rates continues to be the majority probability for the rest of the year,” First Capital added.