Higher interest rates may not come down as early as and as fast as some anticipate

• Central Bank has indicated its resolve to stay course until inflation comes down to meaningful levels  

The pivot in the monetary policy towards cutting rates may not come as early as many would expect, as the Central Bank said it would remain tight as long as it takes to bring inflation down to meaningfully low levels from the current excessive levels, as risks remain in the envisaged disinflation path. 

Announcing its monetary and financial sector policies for this year, the Central Bank last week revealed its commitment to delivering on its core duty, price stability, which it got humiliatingly wrong since 2021, as the price pressures continued to build up and became more entrenched before receiving a jolt from the sudden collapse of the rupee against the dollar. 

Even though there were signs of inflationary pressures building up from around the middle of 2021, the central bankers around the world, including Sri Lanka’s, were of the view that it would be “transitory” and the prices would fix on their own as supply chains get unclogged from pandemic disruptions. 

However, the prices continued to climb and Russia’s invasion of Ukraine sent the prices of global energy, food and other industrial commodities soaring. Although the prices have returned to levels before the war broke out, they still remain much higher than before the pandemic. 

These entrenched and stubborn prices prompted the central banks around the world to launch the most aggressive rate hiking campaign in recent times while Sri Lanka delivered a jumbo 700-basis-point hike in April followed by another 100-basis-point hike in July to counter inflation, which already had spiralled out of control.

While inflation has somewhat decelerated during the last three months, the Central Bank indicated that the monetary policy would stay tight.

“The monetary policy will remain focused on ensuring price stability over the medium term,” the Central Bank said. 

“As guided by the near-term inflation outlook, market interest rates could adjust downward, yet maintain reasonably tight monetary conditions until inflationary pressures are sufficiently contained,” it added. 

The Central Bank’s own medium-term inflation projections pointed to inflation returning its desired band of 4 to 6 percent by the end of 2023, although other outside projections put inflation at over 10 percent. 

Sri Lanka’s inflation, measured by the Colombo Consumer Price Index, slowed to 57.2 percent in December, from just under 70 percent in September when the prices peaked. 

While the easing global energy and commodities prices and potential improvement in domestic supply conditions could bode well on the prices to maintain their current disinflationary trend, the persistent foreign exchange shortages, which could lead to further decline in the value of the rupee and other commodities shortages could have adverse implications on the inflation trajectory. 

The Central Bank however announced some measures such as limiting access to its Standing Facility windows by commercial banks, in a bid to reactivate the interbank market and improve liquidity, which could result in market interest rates easing without cutting the key policy rates.