Rate pause to offer near-term upside for equities: Capital Trust Research

Central Bank’s decision last week to hold policy rates steady is expected to favour equities, according to Capital Trust Research. 

The move reinforces macroeconomic stability and confidence in the ongoing economic recovery process, which should support earnings growth in listed companies, particularly in rate-sensitive sectors.

In a note titled “Policy Pause To Offer Near Term Upside For Equities,” the research firm stated it anticipates the current policy stance to continue through the third quarter of this year. This outlook is contingent on the absence of any unforeseen external events that could derail the current inflation trajectory toward the Central Bank’s 5.0 percent medium-term target.

“We view the policy pause as neutral to mildly positive for equities in the near term,” the research house noted.

The Colombo Stock Exchange has recently been on a record-breaking streak, with the All Share Price Index advancing for six consecutive sessions as of Friday. The broader index has seen a robust 22.1 percent gain so far this year.

At their fourth monetary policy meeting last week, the Central Bank kept its overnight policy rate at 7.75 percent, citing early signs of normalising inflation and firming economic activities.

Capital Trust Research suggested that what appeared to be a dovish pause – maintaining the policy with a bias toward further easing – could lead to a modest rate cut towards the year-end if there’s an abrupt global downturn or sharp rupee appreciation. 

Conversely, the Central Bank could adopt a neutral to hawkish stance, tightening monetary policy by raising interest rates, if inflation overshoots its 5.0 percent medium-term target or external sector pressures re-emerge.

The research house explained that the current monetary policy stance will benefit equities in several ways. The ongoing expansion in private sector credit, coupled with inflation remaining within the target range, will allow consumer and industrial counters to benefit from improving demand and stable input costs.

Meanwhile, the strong growth in private sector credit is expected to boost profits for banks and non-bank finance companies. This will stem from the continued expansion of their loan books and manageable margin compression, supported by falling deposit rates.

Furthermore, equities will also be aided by higher valuations due to a lower risk-free anchor. A stable policy outlook helps keep the cost of equity steady, with falling market interest rates providing room for P/E multiple expansion, especially in mid-cap and domestic consumption-focused names.

The maintenance of the current policy stance also underscores the strength of the external sector, evidenced by a healthy reserve buffer and steady inflows from tourism and remittances. These factors, in turn, enhance foreign investor confidence. The commitment to the ongoing programme with the International Monetary Fund is also likely to support currency stability, further elevating foreign investor confidence.

“This could aid foreign portfolio allocation into equities, especially in export and tourism-linked sectors,” Capital Trust Research added.