Geopolitical tensions put CB in tight spot as it struggles to forecast inflation trajectory

The heightened geopolitical risks and the resulting commodities prices rally led by energy has pushed Central Bank’s inflation expectations off course to a level that the officials are scrambling to provide a path for prices in the medium term. 

Sri Lanka’s inflation measured by the Colombo Consumer Price Index climbed 15.1 percent in the twelve months to February 2022, setting a fresh thirteen-year high. 
However, the path for future trajectory became increasingly unclear with the outbreak of the Russia-Ukraine conflict, which pushed global oil prices to a 14-year high on Monday, just on the talks of embargoes on Russian oil by the United States. 

Oil at the Brent exchange, the global benchmark for oil, topped US$ 130 a barrel yesterday, the highest since 2008. The sharp increase in oil sent the bets on oil towards US$ 200 a barrel in a month, surpassing previous forecasts of US$ 185. 

“We have to appreciate that we have been taken by surprise with the sharp increase in the inflation mainly because of the inflationary aspects that were seen all over the world,” said Ajith Nivard Cabraal, the Governor of Central Bank, responding to a query made on Central Bank’s envisaged inflation band for this year.

“This is something we are concerned about and we believe that we also give some signals to the country and the economy that we want to address inflation as one of the key factors of concern in our economy. 
I know it has increased beyond our normal norms. Thirteen years of single digit inflation has been broken and we are concerned about it because it is our responsibility to ensure that there is price stability that has been to some extent damaged and to ensure that it is brought back,” he added. 

The Central Bank last week raised its key policy rates by 100 basis points to signal the markets that it is willing to act to bring down the demand-driven inflationary pressures, but the most of the other supply-driven factors are beyond the remit of Central Banks.

Cabraal said they would not shy away from any further measures to tamp down prices, but added they wouldn’t have to make the entire inflation adjustment via interest rate as they submitted an eight-point policy package to the government to supplement the monetary policy actions in their fight against inflation and the prevailing foreign exchange crisis. 

“If we have to take certain tough measures we have to take that and that is one reason why we have taken this step (100 basis point rate hike). And, we have also asked for certain other steps so that we don’t have to address it through adjusting inflation only, so that we have a greater opportunity of bringing stability back”, he stressed.