Courtesy Investing.com

Investing.com — The Central Bank of Sri Lanka has announced an unexpected 25 basis point rate cut, capitalizing on the current period of low inflation. The bank appears less convinced about inflation reliably reaching 5% in the second half of 2025.

The bank anticipates inflation to turn positive in the third quarter of 2025 and “gradually align with the target thereafter”. This appears more vague compared to their commentary in March 2025, where they stated that inflation “would reach the targeted levels by year-end”.

Citi has updated its expectations based on this new development. The bank now forecasts another 25 basis point rate cut in July, which would bring the forward-looking real rate to around 2.5%. This prediction stems from the belief that inflation is unlikely to consistently hit 5% in the second half of 2025, real GDP growth is projected to be less than 4% in 2025, and the currency remains stable despite global uncertainties.

However, Citi acknowledges that this is a close call, as there are several risks that could compel the Central Bank of Sri Lanka to maintain current rates.

These include the potential second-order impact of an electricity price increase or an irregular monsoon season driving inflation higher in the second half of 2025, and potential adverse outcomes or delays surrounding a US trade deal, which could reignite external sector risks.