Monetary Board leaves key rates unchanged to further anchor inflation expectations

• Confident of headline inflation coming down to 4-6% range in a year from now 
• Officials sound less hawkish indicating end to the tightening cycle
• Defends months-long tight policy saying as its absence could have driven economy to explode
• Wants interest rates to follow inflation path before cutting policy rates

The Monetary Board of Central Bank as widely expected kept key interest rates unchanged at the current levels of 14.5 percent and 15.5 percent respectively for standing deposit and lending facility rates yesterday maintaining its aggressive monetary policy stance to further support the disinflation path the country is believed to have entered in October.

The inflation hit a peak in September when the prices measured by both Colombo Consumer Price Index and the National Consumer Prices Index reached 69.8 percent and 73.7 percent respectively before easing to 66 percent and 70.6 percent in the following month, handing the Central Bank the first major achievement of the ultra-tight monetary policy it pursued for most part of this year. While there were some expectations for a dovish tilt from this week’s monetary policy meeting, the Central Bank’s Monetary Board expressed its desire maintain the policy rates at their current levels to further anchor inflation expectations towards the desired range of mid-single digits expected for a year from now. 

“The Board noted that the maintenance of tight monetary policy stance is necessary to contain any demand-driven inflationary pressures in the economy, while helping to further strengthen disinflation expectations, thus enabling to steer headline inflation towards the targeted level of 4-6 percent over the medium term,” the monetary policy statement released yesterday stated.  

While the inflation appears to have turned a corner, it is far from alleviating the pressure on the households which are still forced to spend nearly 70 percent more for what they buy compared to a year ago. 

Hence, the Central Bank cannot still claim full victory over defeating inflation. While the Central Bank has purely softened inflation through policies which squeezed demand which took heavy toll on jobs and the economic growth, there are strong arguments that the current bout of inflation is predominantly caused by supply side constraints, at both home and abroad, and thus raising rates was counterproductive in tackling the crisis.  

Hence, calls are growing louder as of late for the Central Bank to lower the interest rates immediately to unshackle the economy to support production and thereby to create jobs and growth. 

However, Central Bank Governor Dr. Nandalal Weerasinghe defended his actions saying that if not for the tight monetary policy, the economy would have blown up after inflating too much.
Nevertheless, the Central Bank’s envisaged inflation path towards 4-6 percent expects gradual improvements in domestic and global supply chains of which the pass through effects would be reflected in the prices of consumer goods. 

Further Dr. Weerasinghe who spoke at the press conference held yesterday to announce the monetary policy did not sound too hawkish indicating that the monetary policy could follow the path of the inflation which is easing, thus relaxing the credit and liquidity conditions conducive for the economic actors.