First Capital says 50% chance for policy rate cut today

• A rate cut today would create history as SL has never seen 5 rate cuts in a row
• Policy rates have been reduced by 200bps since March at 4 consecutive instances

First Capital Research predicts a 50 percent probability for the Central Bank (CB) to cut policy rates for fifth consecutive instance for the first time in history to discourage the banking sector utilising the Standing Deposit Facility Rate (SDFR).  The latest monetary policy review is scheduled to be announced at 7.30 a.m. today. 

“We believe that there is a 40 percent probability for a 50bps rate cut and 10 percent probability for a 25bps cut to discourage the LCBs from using the SDFR facility. Moreover, there is a 50 percent probability to hold rates due to four successive rate cuts in the past,” First Capital Research stated in its pre-policy analysis report. 

For the first time in the country’s history, the CB reduced its policy rates at four consecutive instances providing a total of 200bps rate cut since March this year. 

“With the above initiatives, market interest rates have declined although it hasn’t reflected in private credit growth,” First Capital Research said.

The credit extended to the private sector contracted significantly by Rs.70 billion in May and Rs.54 billion in June due to the impact of COVID-19 while credit growth remains muted at 0.62 percent year-to-date, despite enhanced liquidity in the system through policy rate cuts and SRR cuts. 

With the COVID-19outbreak, policy rates have been cut 103 times globally with many central banks cutting rates multiple times in response to the growing threat. 

However, so far, only four economies (Georgia, Brazil, Romania and Moldova) have cut their rates so far in August while no country reported a hike in policy rates in August. 

Despite the improved liquidity position, yields in the secondary market witnessed a slight increase with moderated activities as market participants were seen following a wait-and-see approach amid the upcoming policy review.

“Weighted average yields at the weekly T-bill auction on 05th August were seen increasing, with the 1 Year maturity rising by 8bps to 4.94 percent, for the first time in 21 weeks. We believe a further policy cut would be required to sustain the yields at current levels in line with the low interest rate environment,” First Capital Research said.

Sri Lanka’s economy contracted by 1.6 percent in the first quarter against 3.7 percent growth in the corresponding period of the previous year, flagging off concerns, as the negative growth was before the COVID-19 impact.

“We expect that the impact of COVID-19 disruptions will be felt much more in the 2Q2020, as it continued to spread throughout the country since mid March 2020. Moreover, decline in global demand for the country’s exports and delays in raw material procurement, and no tourist arrivals due to travel restrictions further heightens the risk of lacklustre GDP growth concerns for 2020E,” First Capital Research noted.

However, possible inflationary woes could arise with further easing and due to prevailing sufficient liquidity in the system, which could influence the CB to maintain its current policy rates. 

“There can be a possibility that this time CBSL prefers to conserve its policy space and use it judiciously in the latter part of the year, reflecting a lesser probability of further rate cuts at the 
upcoming review.

If a policy rate cut is not provided in Aug. 2020, and if low credit and GDP growth persist beyond 2Q, we believe that there is a higher probability of easing policy rates in Oct. 2020 (60 percent probability) or Nov. 2020 (75 percent probability) to provide more stimulus to the economy,” First Capital Research said.

Market bets on further monetary easing: ICRA Lanka

The market is betting on further monetary easing after little more than a month since the Monetary Board delivered a 100 basis point cut in the key policy rates, accelerating the downward shift in market lending rates. 

The broadly stable prices and relatively less pressure on the rupee and the robust recovery of the economic activity provides the Monetary Board of the Central Bank to consider another rate cut in view of providing further stimulus to the economy, some economic analysts opined. 

“The inflation will remain mild. There is a possibility for the CBSL to consider a rate cut, which may drive the interest rate further down,” said ICRA Lanka, part of Moody’s Investors Service on the monetary policy decision due today. The rating agency broadly echoed the view of those who expect the Monetary Board to further support the economy. 

However, some are of the view that the Monetary Board could stay pat this week after delivering a surprise 100 bps point cut just over a month ago as its effects are already seen by way of faster adjustment in market lending rates.  

The July cut in the key rates sent the prime lending rate by 111 bps down by the end of last week to 7.00 percent, 

while the benchmark rate has fallen by a total of 274 basis points from the beginning of this year in response to the cumulative 250 bps cut in the key rates by the Monetary Board this year.

However, the arguments for further easing of rates outnumbered the arguments against it as private sector credit still remains at nascent levels despite availability of liquidity. 

The interim results released by commercial banks showed that their deposit growth has outpaced their lending growth by a few times, weighing on their net interest income because they operate with heavy excess liquidity. 

Excess liquidity is typically parked in government securities, of which the yields have fallen to extremely low levels in recent times resulting in lower yields for those who hold them. 

Hence, the banks want to see growth in their loan books at least during the remainder of this year, which could help them to offset at least part of the negative impacts coming from the pandemic and report decent profits.