CB expected to hold rates tomorrow after surprise hike in Aug.

■ „Continuous need to support pandemic battered economy funding for government cited as key reason ■ „But FCR says pressure on foreign currency after relaxing some import control may push CB to consider another rate hike

■ „CB hiked policy rates by 50bps in surprising move at last monetary policy review

There is a greater likelihood for the Central Bank to maintain the current monetary policy stance at today’s monetary policy meeting—which will be announced tomorrow, given the damage caused to the economy in the third quarter by the prolonged lockdowns and the need to support the government through liquidity when other financing sources have nearly run dry, according to First Capital Research (FCR).

The Central Bank surprised the markets with a 50 basis points hike in key policy rates on August 19, citing the need to address external sector imbalances and also as a preemptive measure to fend off any persistent inflationary pressures.

But, FCR said any more rate hikes could not contain price pressures as they are mostly “cost push,” though they might support the currency to stabilise.

However, it did not rule out the possibility of a further rate hike tomorrow to prevent the overheating of the economy and also considering the improvement in some of the key economic readings such as the solid private sector credit growth recorded through August.

“We believe that CBSL may consider maintaining the same policy stance in this policy review, but given the considerable improvement in high frequency indicators to prevent an overheating of the economy, there is a considerably high probability (30 percent) that CBSL may hike its policy rates,” FCR said in its customary pre-policy analysis released prior to Thursday’s monetary policy decision.

The Monetary Board is meeting today for the seventh time for the year and for the first time since Ajith Nivard Cabraal took over as the Governor in September to determine the trajectory of interest rates as they are confronted with the difficult choice of maintaining monetary support, which is neither prohibitive of economic growth nor leads to overheating of the economy.

However, rising yields of government securities during the last three weeks since the yield caps were lifted could also make a case for the Monetary Board to consider raising key rates, which will provide more clarity to market participants and thereby enabling the government to raise more funds through government securities. Citing another argument why a rate hike may warrant at this juncture, FCR said it could preserve foreign currency form the potential pressure mounting from the relaxing of import restrictions seen lately, which adds to the already rising import bill in the five months through July.

The stronger growth in August private sector credit to a three-year high despite negative liquidity could also prompt some tightening by Monetary Board to slow the pace of credit, which could lead to overheating if the Central Bank deems the trend would sustain.

However, it is yet to be seen if August private sector credit could be any signal for of the subsequent months’ credit growth as it happened before the rate cut came into full effect.

Under these conditions, FCR predicted a 25 to 50 basis point hike, if the Monetary Board chooses to raise the key rates further this week, but ruled out any possibility for a rate cut under the current circumstances.