Central Bank rate cut “inevitable”

Wednesday, 29 May 2019 01:46 - - {{hitsCtrl.values.hits}}

First Capital Research says probability rate at 95%
Sluggish growth, Easter Sunday attacks, improved macro fundamentals seen as key reasons
Rate cut also likely given alarming deceleration of private sector credit
Predicts economic recovery will take at least one year, downgrades growth to less than 3%

First Capital Research yesterday said there is a 95% probability for a policy rate cut when the Central Bank announces its latest monetary policy stance on Friday.

Releasing its policy expectations, First Capital said a rate cut was “inevitable,” given slowing growth and the impact of the Easter Sunday attacks.

“We are of the view that policy intervention is inevitable to revive the overly sluggish economy and credit growth. Despite the Road Map towards a single policy rate, we believe a rate cut in both SLFR and SDFR is more appropriate, considering the severity of the situation. However, in the case of a 75bps or a 100bps rate cut consideration, though remote, Central Bank may consider a lower cut for SDFR,” the report said.

First Capital Research pointed out that the Monetary Board had previously observed that the continuation of the monetary policy stance was appropriate but had hinted at possible monetary easing. This has since been reinforced by statements from the Government calling for banks to reduce interest rates.

Macroeconomic fundamentals have also steadily improved creating space for a policy rate cut.

The Central Bank maintaining foreign reserve position above $7.0 billion ($7.2 billion by end April 2019) is noteworthy considering the major outflows in April 2019. The International Monetary Fund (IMF) approved the 6th tranche of $164.1 million while granting a one year extension until June 2020, providing a cushion to country’s economy to recover from the recent attacks, pointed out First Capital Research.

“Falling below the Central Bank credit growth projection of 13.5%, private sector credit growth decelerated at an alarming rate to record an YTD growth of 0.5% during the first quarter leading to a contraction in financial sector asset base,” it added.

The Sri Lankan rupee continued to strengthen to close at 176.24 on 22 May, supported by foreign remittance conversions and foreign inflows during the festive seasons. However, REER continued to remain undervalued at 94.74 in March 2019.

A sustained positive liquidity position was created after the lapse of six months resulting from multiple Statutory Reserve Ratio (SRR) cuts and the Government making long delayed payments, providing the ability for the Central Bank to discontinue daily reverse repo auctions and term reverse repo auctions.

“The Easter Sunday attacks are expected to have a detrimental impact on the economy, possibly further slowing down the sluggish economy. We expect the recovery would require at least one year period forcing a downward revision to our 2019 GDP growth projection to below 3% from previous 4.3%.”