Sri Lanka hikes interest rates to contain inflation

The Central Bank of Sri Lanka (CBSL) raised its key rates by a full percentage point on Thursday to tackle record-high domestic inflation and to contain any build-up of underlying demand, it said.

The Standing Lending Facility rate was raised to 15.50 per cent while the Standing Deposit Facility Rate rose to 14.50 per cent, the highest in 21 years.

Inflation touched a record 54.6 per cent year-on-year in June while food inflation accelerated to 80.1 per cent.

"The Board was of the view that a further monetary policy tightening would be necessary to contain any build-up of adverse inflation expectations," CBSL said in a statement.

The policy adjustment would help guide inflation expectations to be anchored around the targeted 4-6 per cent level over the medium term and curtail any build-up of underlying demand pressures in the economy, it said.

The island of 22 million people is wilting under a severe foreign exchange shortage that has it struggling to pay for essential imports of fuel, fertilisers, food and medicine.

The CBSL had raised rates by a massive 700 basis points in April but held them steady at its previous policy meeting in May.

The central bank said domestic economic activity during the second quarter of 2022 is expected to have been severely affected by the continued supply side disruptions, primarily due to the shortages of power and energy.

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There has been significant progress made in the negotiations with the International Monetary Fund for a credit facility while negotiations are on with bilateral and multilateral partners to secure bridge financing, the CBSL said.

"Bond yields shot up on Wednesday on the expectations of about a 500 basis point increase but what is interesting is the central bank is anchoring it's decision on Sri Lanka seeing dis-inflation in the second quarter of 2023," said Udeeshan Jonas, chief strategist at equity research firm CAL.

"Given the global changes, including oil prices trending downwards, is clear the central bank is taking a measured approach and focusing on real interest rates and not matching cost-push inflation," he added.