Equal bets on a rate hike and maintaining current policy rates

• Analysts see a strong case for hiking rates on external sector woes  
• Point out monetary policy cannot address supply-driven inflation

First Capital Research (FCR), releasing its customary pre-policy analysis ahead of today’s monetary policy announcement, threw its bets equally between an increase in the key policy rates and leaving the rates at the current levels, as arguments for both sides are getting stronger, presenting an extremely difficult choice for the Monetary Board when deciding the future trajectory of the rates. 

However, in spite of today’s announcement, the research house maintained that the future monetary policy would increasingly be tilted towards a more hawkish stance, given the country’s fragile external sector conditions and the global trend towards a more tighter monetary policy, to address the global inflationary pressures. 

Sri Lanka’s Monetary Board met last evening for the eighth time this year, perhaps in the toughest times ever to decide on the monetary policy, as they have to find a fine balance between supporting the recovery of the virus-struck economy and maintaining price stability to ensure that people’s real incomes aren’t eroded.  

“We believe that the CBSL may consider tightening the monetary policy rates in this policy review but given the concerns over economic growth, there is a considerable probability of 50 percent for the CBSL to maintain its policy stance at current levels,” FCR wrote in its pre-policy analysis. 

“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,” the research agency added.

Sri Lanka is going through a bout of exponentially higher prices, from staples to discretionary to everything, as its consumer prices rose by a four-year high of 7.6 percent in October, measured annually, from 5.7 percent in September. 

The foreign exchange liquidity crunch and price controls created shortages in cooking gas to milk powder to cement to others, which are still found to be rationed, as people are still being forced to line up in queues in front of stores to obtain their essentials for their survival. 

However, FCR, expressing similar sentiments to that of the Central Bank officials, said the current spike in inflation is predominantly supply driven and therefore, “cost push inflation cannot be addressed via monetary tightening”. 
The majority global central banks are dialling back their pandemic era monetary policy support by raising their interest rates and also to fend off the rising inflationary pressures, which caused partly by the supply chain bottlenecks, shipping delays and massively high freight costs. 

Unlikely in other economic crises, the record stimulus unleashed by the central banks and governments around the world sparked a massive pent-up demand, which still continues to date but the supply could not catch up, due to the sheer burst in the demand, which was then worsened by the interruptions caused to the supply in the key producing regions in Asia, due to fresh virus outbreaks this year, while the West was reopening with massive amounts of moneys being distributed via stimulus checks. 

As a result, the United States consumer inflation hit a three-decade high of 6.2 percent in October from a year ago, massively overshooting from their desired goal of 2.0 percent. 

The reappointment of the current Fed Chair Jerome Powell for a second four-year term on Monday reassured the continuity and the stability of the monetary policy for the markets and the analysts are betting the first rate hike by the Fed to come as early as June, after the end of the tapering of the current bond buying programme by April. 
Global central banks in total have raised their benchmark rates by a cumulative 655 basis points in November so far, far outstripping the rate cuts, which came only from Turkey by 100 basis points, as its central bank’s independence is highly compromised by the country’s executive branch.

Bank of England is widely expected to cut rates in December after staying the rates earlier this month. 
Sri Lanka’s Central Bank raised its benchmark short-term rates by 50 basis points in August, to addressed the foreign exchange market anomalies and also to pre-empt any price pressures and since then the yields and rates of the government securities and other market rates have climbed, albeit some levelling off is seen in the last couple of weeks. 

Supporting its arguments for another rate hike, FCR cited the sovereign rating downgrades amid deleted reserves, dwindling rupee liquidity amid strong private sector credit growth and further pressure on the currency from relaxing imports as compelling reasons for a rate hike to ward off any more pressure stemming from these areas and thereby re-establish stability in the economy. 

“A hike in interest rates may have a positive impact on the exchange rate and thereby preserving foreign capital while promoting the economic stability of the country,” it said adding that the rate hike would also slowdown the credit flows into consumption and shift money flows into savings and investments, which helps to tamp down any demand pressures in the economy prevalent at present.