Central Bank delivers 50bps policy rates cut

• Says softer than expected inflation provided space to resume cuts
• Expresses confidence of maintaining mid-term inflation at targeted range between 4% to 6%
• Says impact from VAT on prices is lesser than expected

The Central Bank yesterday resumed cuts by further reducing key policy rates by 50 basis points as inflation remains anchored. The move was also to further ease the financial conditions with a view to support and accelerate the expansion of the economy.

The rates cut came after a four months hiatus since November 22 last year, when the Central Bank said they would pause any more reduction until both, the government securities yields and the lending rates, fall broadly in line with the policy rates.

Although both yields and rates eased thereafter, quite notably the yields showed some reversal in the last four weeks while the softening in lending rates slowed, the Central Bank said.

After cutting rates, the rate setting committee stressed the need for the financial sector to swiftly and fully pass through the benefits of the easing the monetary policy and thereby accelerate the normalisation of market interest rates in the period ahead.  

Yesterday’s cut brought the total drop in key rates to 700 basis points since the Central Bank pivoted to the monetary easing cycle in June last year. With the latest cut, the Standing Deposit and Lending Facility rate now stand at 8.50 and 9.50 percent.

Although some market participants expected the Central Bank to come up with single policy interest rates instead of the current two, the officials said the Committee is still studying it.

The language of the monetary policy statement and the tone of the officials at the media briefing held soon after suggested a growth bias and also that the Central Bank has a better hold on inflation as prices are coming in softer than expected in February, within their medium term target range of 4 to 6 percent.

For instance, the inflation measured by the Colombo Consumer Price Index (CCPI), officials’ preferred gauge of prices, cooled to 5.9 percent in February from 6.4 percent in January due to easing supply conditions and also the dissipation of the effects from the value added tax hike in January.

Meanwhile, the core inflation which strips out the often volatile food, energy and transport, and measures the underlying demand pressures of the economy came much softer at 2.8 percent in February.

The officials said the aggregate demand conditions remain subdued while there was a lesser than expected impact from the recent changes to the taxes which gave them space for the latest cut in key rates.

The Central Bank, although too late, underscored the recent inflation and also the expected inflation are predominantly driven by supply side factors and administratively determined prices.

“The Board viewed that the reasons for the recent and expected changes in inflation in the upcoming months were propelled by supply-driven and administratively determined prices, while noting that inflation expectations remained well anchored”, the monetary policy announcement said.

While global energy prices remain a wild card, the officials said the favourable near term dynamics such as recent downward adjustments to electricity prices, well anchored inflation expectations and the absence of the excessive external sector pressures helped to relax the financial conditions and thereby support the economy to change gear.

Central Bank Governor, Dr. Nandalal Weerasinghe said, with the absence of major shocks, they see the ability to maintain inflation at the targeted level in the next 12 to 18 months.