Hotter inflation unlikely to trigger fresh rate hikes: Bloomberg Economics

• Says inflation to drive to an average of around 7% in 4Q 2026, before easing toward Central Bank’s 5% target by mid-2027
• Argues last month’s larger-than-expected rate increase “should be enough restraint for now”

By Nishel Fernando

Sri Lanka’s inflation is set to climb further through the rest of 2026 but the Central Bank is expected to hold the interest rates steady for the remainder of the year, according to a research note by Bloomberg Economics.

Headline inflation, as measured by the Colombo Consumer Price Index, rose to 6.8 percent year-on-year in June, up sharply from 5.5 percent in May and marking a three-year high, according to the data from the Census and Statistics Department. 

The reading came in above Bloomberg Economics’ own forecast of 6 percent and the consensus estimate of 5.8 percent, with the agency attributing the acceleration to higher food and fuel prices.

South Asia Economist Ankur Shukla of Bloomberg Economics said the price pressures are likely to keep building, with the solid domestic demand, higher energy costs and favourable base effects driving inflation to an average of around 7 percent in the fourth quarter of 2026, before easing toward the Central Bank’s 5 percent target by mid-2027. 

For the full year, Bloomberg Economics projects an average inflation of 5.5 percent, a forecast that assumes the oil prices average US $ 80 a barrel in the second half of the year and the rupee holds around the current levels.

Despite the sharper-than-expected pickup, Bloomberg Economics does not expect the Central Bank to tighten policy further this year, arguing that last month’s larger-than-expected rate increase “should be enough restraint for now”. 

The Monetary Policy Board raised its Overnight Policy Rate by 100 basis points to 8.75 percent in May, ending a pause that had held since June 2025 and following an earlier cycle in which the Central Bank had cut rates by a cumulative 825 basis points. Bloomberg Economics expects the Central Bank to begin easing again around mid-2027, as inflation recedes and creates room to support growth.

The bulk of the recent price pressure traces back to a steep upward adjustment in the domestic fuel prices, which were raised by roughly 47 percent, in response to the supply disruptions linked to the conflict in the Middle East and rising global oil costs. The Central Bank itself flagged this dynamic in its most recent inflation release, noting that headline inflation had already run marginally above the target in May, reflecting the upward adjustments to the domestic energy prices amid the regional conflict.

Bloomberg Economics said the risks to its inflation forecast are tilted to the upside. A re-escalation of the Iran-related conflict in the Middle East could push the oil prices higher still and weaken the rupee, while the adverse weather that lifts the food prices further would add to the pressure. Conversely, the agency said inflation could undershoot its forecast, if the oil prices settle closer to US $ 70 a barrel in the second half of the year.

The inflation build-up comes as Sri Lanka continues to implement reforms under its International Monetary Fund (IMF)-supported Extended Fund Facility (EFF) programme and the latest reading has drawn particular scrutiny because it has now moved further beyond the Central Bank’s target, potentially inviting closer examination under the IMF’s reform framework. Even so, the IMF stopped short of sounding the alarm on the June print. 

Concluding a staff visit to Colombo that ran from June 24 to 30, IMF Mission Chief for Sri Lanka Evan Papageorgiou told journalists it was too early to say whether the reading marked a temporary spike or the start of a broader trend.

“This number just came out. It would be premature for me to comment on this because you have to remember also the quarterly basis; it’s not just a monthly basis,” Papageorgiou said.

He said the IMF’s assessment of inflation is anchored to the Central Bank’s own target framework, under the programme’s Monetary Policy Consultation Clause. 

“From the IMF perspective, the Monetary Policy Consultation Clause, that is, we adopt also the Central Bank’s target and we evaluate the performance of inflation within that Central Bank target,” he said, adding that the IMF’s Executive Board would examine whether inflation had come in above or below target and for what reasons once it takes up the matter. 

“When the time comes and we go to the Executive Board, we will evaluate what is the outcome for inflation and whether if it’s above or below; we have to consider how is this being met or not being met and for what reasons,” he said. 

Sri Lanka’s programme performance is due to be formally assessed at the Seventh Review of the EFF arrangement, expected in September.

The IMF’s cautious posture follows the Central Bank’s surprise 100-basis-point policy rate hike in May, its first rate increase since March 2023, which has already pushed up the lending rates for the households and businesses. With the IMF declining to speculate on further policy action, the implication is that the authorities are taking a wait-and-see approach until a clearer picture emerges on whether the recent pressures are becoming entrenched.

Separately, the IMF Executive Board completed the combined Fifth and Sixth Reviews of the four-year US $ 3 billion EFF arrangement in late May, releasing about US $ 695 million in fresh financing. In a statement issued after that review, IMF Deputy Managing Director Kenji Okamura said Sri Lanka’s reform programme had continued to deliver despite the challenging circumstances but that the Middle East conflict had significantly worsened the country’s economic outlook and tilted risks to the downside, with the growth for 2026 now projected to slow to around 3 percent as higher oil prices push up inflation and weaken the current account.

For its part, the Central Bank has said the inflation trajectory so far this year has been broadly in line with the projections it set out at its May monetary policy review and has reiterated that the price growth is likely to stay above the 5 percent target in the near term, before easing and stabilising around that level over the medium term, supported by the appropriate policy measures.