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Interest
rate hike not seen reining in inflation
The Central Bank raised its overnight repurchase rate to 7.75 percent from 7.5 percent while the reverse repo rate was increased to 9.25 percent from 9.0 percent. The move came days ahead of a key meeting of international lenders and aid donors in Kandy to review economic progress and tsunami relief and followed pressure from donors to curb inflation. "These measures would help to bring monetary expansion to the desired path and reduce inflationary pressures and inflationary expectations in the economy," the bank said in a statement. However, market analysts have downplayed the importance of higher interest rates in curbing inflation. Stock brokers Asia Securities said this was because inflation is largely driven by cost-push factors such as soaring oil prices. While rising inflation may prompt the Central Bank to consider interest rate hikes during the second half of 2005, higher interest rates will not directly address the country's soaring prices, they said in a report issued before last week's Central Bank rate hike. Rising prices appear to be driven primarily by cost-push (i.e. higher crude oil prices) and not demand-pull factors. Higher interest rates will ease prices in an over-heating economy with demand-pull inflation, partly arising from excess demand for credit. "In our opinion, the Sri Lankan economy is not suffering from excess demand, and higher interest rates will only have a limited indirect effect on easing inflation, by way of a stronger currency," Asia Securities said. "With the benefits of a stronger currency also yet to be passed on to end-consumers, and higher gas and electricity prices also imminent, we are consequently increasing our year-end target for CCPI inflation from 12 percent to 14 percent, up from 7.6 percent in 2004." |
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