The Monetary Board of the Central Bank has decided to reduce the Standing Deposit Facility Rate and the Standing Lending Facility Rate by 200 basis points to 11.00 percent and 12.00 percent respectively.The Central Bank said it took this decision at the monetary board meeting conducted on Wednesday.

The board arrived at this decision following a careful analysis of the current and expected developments, including the faster-than-envisaged disinflation process and benign inflation expectations in the domestic economy, with the aim of enabling the economy to reach its potential and stabilizing inflation at mid-single-digit levels in the medium term, while easing pressures in the financial markets, the Central Bank statement said.

The board expects that with this reduction of policy interest rates by 200 basis points, and the reduction of policy interest rates by 250 basis points in early June 2023, along with the significant reduction of risk premia on government securities witnessed recently, the market interest rates, particularly lending rates, will adjust downwards adequately and swiftly, said the central bank.

Therefore, the banking and financial sector is urged to pass on the benefits of this significant easing of monetary policy by the central bank to individuals and businesses, thereby supporting economic activity to rebound in the period, the statement said.

The CBSL said Colombo Consumer Price Index (CCPI) (2021=100) based headline inflation (year-on-year) decelerated further in June 2023 to 12.0 per cent, reflecting easing price pressures across many categories, including energy and food prices, along with the favourable base effect.

CCPI based food inflation (year-on-year) and core inflation (year-on-year), which reflects underlying inflation, moderated to single digit levels in June 2023, reinforcing the disinflation process. The full pass through of the appreciation of the Sri Lanka rupee against the US dollar thus far in 2023 is yet to be reflected in the price levels, a factor that could further support the disinflation process.

As per the latest projections of the Central Bank, headline inflation is expected to decelerate further and reach single digit levels by early Q3-2023 and stabilise around mid-single digit levels over the medium term, the CBSL said.

The ongoing disinflation process is supported by the lagged impact of tight monetary and fiscal policies, the expected softening of energy and food prices and their spillover effects, and possible repricing of goods and services due to exchange rate appreciation, alongside the favourable impact of the statistical base effect, CBSL said.

CBSL added that domestic economic activity is expected to recover gradually towards late 2023 and sustain the recovery, thereby helping to reach the potential level of economic growth over the medium term.

As per the GDP estimates published by the Department of Census and Statistics (DCS), the real economy contracted in Q1-2023, driven by a substantial contraction in Manufacturing and Services sectors. According to the leading indicators, economic activity is estimated to have remained subdued in Q2-2023 as well, reflecting the protracted impact of the economic distress in 2022 coupled with the tighter monetary and fiscal policies implemented to bring in greater macroeconomic stability.

However, the economy is projected to recover gradually towards late 2023, supported by policy normalisation led by the easing of monetary conditions, improvements in supply conditions supported by strengthened foreign exchange liquidity, the gradual relaxation of import restrictions, enhancement in business and investor sentiment, and the impact of policy measures and structural reforms being implemented to promote economic growth.

This recovery is expected to sustain, thereby gradually closing the large negative output gap that exists in the economy and reaching the potential level of economic growth over the medium term.