Sri Lanka central bank holds rates, sees sharp drop in inflation

Sri Lanka's central bank kept interest rates steady on Tuesday and expressed optimism that prices would decelerate sharply in the coming months, in its first policy decision since securing a $3 billion bailout from the International Monetary Fund.

The Central Bank of Sri Lanka (CBSL) held its standing deposit facility rate and standing lending facility rate at 15.50% and 16.50%, respectively.

"The maintenance of the prevailing tight monetary policy stance is necessary to ensure that monetary conditions remain sufficiently tight to facilitate the continuation of the ongoing disinflation process," the CBSL said.

Central bank Governor Nandalal Weerasinghe said a favorable base effect would kick in from next month while reductions in fuel prices would help achieve a faster pace of disinflation going ahead.

"We are confident inflation will come down to single digit levels by end of December," he said.

CBSL last raised rates by 100 basis points in early March - its first increase in seven months - as part of efforts to finalize a four-year IMF program to help the island emerge from its worst financial crisis in more than seven decades.

The central bank's rate decision was largely in line with expectations following a stubborn inflation reading of 50.3% in March.

"Key message covered seems to be that CBSL expects the domestic debt restructuring announcement to reduce the risk premia attached to yields. So far markets have moved in line with that expectation," said Thilina Panduwawala, head of research at Frontier Research.

Any easing of rates will likely happen around September or October, analysts polled by Reuters said, broadly in line with the central bank's predictions.

Headline inflation will stabilize at desired levels over the medium term, CBSL said in its policy statement.

Separately, the financially strapped South Asian country has said it would start formal negotiations to restructure the debt it owes to bilateral creditors and overseas bondholders after its domestic debt operation, aiming to complete these parallel debt talks by September, in time for the first IMF review.

Weerasinghe said he was keen for the debt talks to be concluded as soon as possible.

Sri Lanka will kick off a reworking of part of its domestic debt next month and aims to finalize it by May.