First Capital Research assigns 60% probability for a policy rate cut announcement on Thursday

First Capital Research (FCR) has assigned 60 percent probability for the Central Bank to cut policy rates at the upcoming seventh monetary policy announcement for this year on Thursday, October 5.
“We believe that there is a 60 percent probability that the CBSL may consider relaxing policy rates in the upcoming policy review meeting, moving into a dovish stance, with a view to stimulate economic growth and accelerate the decline with interest rates,” FCR said.
“With economic indicators stabilising and the economy projected to recover during 2H2023, with a drastic slowdown of inflation witnessed in 3Q2023, we believe a sizeable monetary relaxation may be required in the latter part of 2H2023,” it added.

However, considering both arguments for and against monetary easing, FCR has assigned a 40 percent probability for policy rates to be maintained at the current rates, allowing further strengthening of key economic indicators.
The Central Bank maintained the Standing Deposit Facility Rate (SDFR) and Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels of 11.00 percent and 12.00 percent, respectively, at the monetary policy review announced on August 24, 2023.
The Monetary Board acknowledged the decrease in market interest rates due to previous monetary policy measures and stressed the need for further adjustments. However, it noticed that some lending rates were still too high and not in line with the current monetary policies. 

The board expects a quicker decrease in overall lending rates, in line with the recent policy changes. 
Consequently, the Central Bank decided to implement targeted administrative measures to lower certain lending rates and instructed the licensed banks to decrease the rupee lending rates by an appropriate margin in the near future.
Meanwhile, Sri Lanka’s official inflation declined sharply to 1.3 percent in September, on a year-on-year basis, from 4 percent in August, making a strong case for further monetary policy relaxation.
FCR noted that reduced inflation is a sign that tight monetary circumstances have nearly entirely eliminated demand forces.

At the same time, Sri Lanka’s economic growth contracted 3.1 percent in the second quarter of 2023, against 7.4 percent n 2Q22, indicating a sharp slowdown in the GDP contraction, in light of decelerating inflation and anticipated interest rate stabilisation. However, negative influences stemming from the potential delay in the International Monetary Fund’s second tranche of US $ 330 million, may stand in the way of further monetary policy easing, FCR noted.

Throughout the year, the Central Bank implemented significant rate cuts, reducing the SDFR and SLFR by a total of 450 basis points and lowering the SRR to 2.00 percent in August 2023. Consequent to the back-to-back cuts, market lending rates too have showcased sizeable downward adjustments, driven by a heavy buying appetite. 
“Hence, it is fitting to desist from a monetary stimulus and resort to a wait-and-see approach to ward off against any macroeconomic pressure that may arise from a relaxation in policy rates,” FCR noted.