NDB Securities says probability to cut rates by 250 - 300 bps

NDB Securities says there is a probability of a 250-300 basis points cut in policy rates by the Monetary Board when it meets today.

“In our view, there is a high probability to cut rates by 250-300 bps: Due to the sharp deceleration in inflation and the significant downward adjustment in market interest rates following the DDO announcement, we anticipate that the central bank is likely to cut rates by at least 250-300 bps in the July MPC meeting,” NDB Securities said.

“The spread between the current policy rates (SDFR at 13% and the SLFR at 14%) and the expected inflation is significantly high at present. Therefore, considering the projected decline of inflation to high single digits in July 2023, it is evident that a substantial adjustment in policy rates is warranted. A policy cut will also have a strong signalling effect on the market, helping to bring down the overall market interest rate structure and contribute to a faster recovery of economic growth,” NDB Securities added.

It said CBSL made a policy pivot in June 2023: In an unexpected move, the Central Bank of Sri Lanka (CBSL) cut policy rates by 250 bps during the last MPC meeting, effectively ending the 21-month long tightening cycle. The main reason cited for this policy pivot was the faster-than-expected deceleration of inflation. Since then, market rates have significantly decreased.

“Additionally, in our last MPC review report, we predicted that the central bank’s decision to pivot its policy was also driven by the objective of making the DDO more acceptable to participating bondholders, while reducing the overall cost of borrowing,” NDB Securities said.

It also said DDO was better than feared and G-Sec yields adjusted downward sharply on Tuesday. On 28 June 2023, the Government announced its domestic debt restructuring plans. Yesterday, the first trading day after the DDO announcement, yields on government securities fell sharply, with the DDO risk premiums coming off. The market was anticipating the worst in terms of the DDO plans, but the Government’s proposal was better than feared, as it only included superannuation funds and the central bank in the local currency debt envelope. Secondary market bond yields decreased sharply yesterday, by approximately 10-12%, and the benchmark 5-year bond yield currently hovers around 13.75%, compared to its closing of 23.2% on 28 June.

NDB Securities also noted that inflation continues to come down with food inflation dropping to 4%, a two-year low.

In the latest June 2023 CCPI print, headline inflation fell to 12.0% from 25.2% in the previous month. Core inflation followed suit, dropping to single digits at 9.8% from 20.3% in May 2023. Food inflation converged with the CBSL’s lower inflation band corridor at 4.1% after a two-year hiatus. The sharp decline in inflation is attributed to the favourable statistical base effect, softening commodity prices, and the recent USD/LKR dynamics.

“We expect that inflation in July 2023 will decrease to high single digits and decline further in August 2023,” it said.