CBSL holds policy rate at 8.75% as inflation remains elevated due to Mideast war

The Central Bank of Sri Lanka (CBSL) yesterday said it will keep its policy rate unchanged at 8.75%, weighing the effects of its pre-emptive tightening in May against an energy-driven inflation spike it expects to persist into early 2027.

The Monetary Policy Board held the Overnight Policy Rate (OPR), the Bank’s main policy rate, at 8.75%, the CBSL said yesterday. The Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR), which set the floor and ceiling for overnight interbank borrowing, remain at 8.25% and 9.25%, respectively.

The Board said it paid particular attention to the effects of the May tightening alongside other measures already in place, and flagged uncertainty from geopolitical tensions in the Middle East and potential El Niño-related risks to the economy. The OPR was raised by 100 basis points (1 percentage point) from 7.75% in May.Headline inflation, measured by the Colombo Consumer Price Index (CCPI), rose to 8% year-on-year (YoY) in August, from 7.3% in July and 2.1% in December 2025. The broader National Consumer Price Index (NCPI) rose to 8.1%. The CBSL attributed the increase to the pass-through of the energy shock across multiple sectors. Inflation accelerated sharply from April, when the CCPI rate jumped to 5.4% from 2.2% in March.

Core inflation, which strips out volatile food and energy prices and is a gauge of underlying price pressures, also rose, reaching 5.1% on the CCPI and 6.3% on the NCPI in August. The Bank said this reflected spillovers from higher energy prices.

The CBSL projects headline inflation to stay in high single digits through the first quarter of 2027 before easing towards its 5% target, which was agreed with the Finance Minister under the Monetary Policy Framework Agreement in October 2023. It said medium-term inflation expectations remain broadly anchored around the target despite the current spike.With August inflation at 8%, the policy rate stood 75 basis points above the headline rate.

The Bank cautioned that its projections, based on information available as of 29 September 2026, are subject to elevated uncertainty given the fluid situation in the Middle East. It identified upside risks to inflation from a further escalation or prolongation of geopolitical tensions, which could raise domestic energy, transport, and fertiliser costs; more severe El Niño-linked weather affecting agricultural output; and rupee depreciation driven by adverse sentiment or external shocks. Downside risks include larger-than-expected declines in global energy and commodity prices and a milder El Niño impact.

The projections are also conditional on the anticipated fiscal path of the Government, growth among Sri Lanka’s major trading partners, and global financial conditions implied by the US Federal Reserve’s policy rate.

The economy grew 4.7% YoY in the first half of 2026, according to Department of Census and Statistics estimates released in September. Growth slowed to 4.2% in 2Q from 5.1% in 1Q, and compared with 5% for full-year 2025.Industry remained the main driver, expanding 7.3% in 2Q, while services growth slowed to 2.7%. Agriculture contracted 2.3% in the quarter, leaving the sector 0.6% smaller in 1H. The CBSL said leading indicators point to continued momentum, though global and climate-related uncertainties could weigh on the outlook.

Growth in credit to the private sector is gradually moderating in response to recent policy measures, the Bank said, adding that credit flows are expected to remain sufficient to support economic activity. Outstanding private sector credit rose to Rs. 11.5 trillion in July, an increase of Rs. 1.2 trillion or 12.1% from December 2025. The monthly increase slowed to Rs. 169 billion in July from Rs. 246 billion in June. Net credit to the Government fell by Rs. 465 billion over the same period to Rs. 7.8 trillion, while broad money (M2b) grew 6.7% to Rs. 17 trillion.

Borrowing costs have continued to rise. The Average Weighted Prime Lending Rate, charged to banks’ most creditworthy customers, rose to 10.94% in the week ending 25 Septemberfrom 9.86% at end-March. The Average Weighted New Lending Rate climbed to 12.65% in August from 11.33% in March, while the rate on new loans to small and medium enterprises (SMEs) reached 13.08%.

Government securities yields have eased from their mid-year peaks. At the 23 September auction, the 91-day Treasury Bill yield was 9.2%, down from 10.14% at end-June, while the 364-day yield stood at 9.93%, against 10.2% at end-July. The average overnight interbank call money rate was 8.96% as at 29 September, above the OPR.

On the deposit side, the Average Weighted Fixed Deposit Rate rose to 9.34% in August, though the rate on new fixed deposits eased to 8.31% from 8.85% in June.

The current account is estimated to have returned to surplus in August after four consecutive months of deficits, the CBSL said, supported by moderating merchandise imports and higher earnings from tourism and workers’ remittances.Gross official reserves rose to $ 6.9 billion at end-August, including the swap facility from the People’s Bank of China, helped by net foreign exchange purchases by the CBSL.

The rupee appreciated against the US dollar in July and August before moving in both directions in September. The Bank said the recent sovereign rating upgrade is expected to further strengthen market sentiment.

The CBSL said it would remain forward-looking and data-dependent. Should inflationary pressures intensify or expectations show signs of de-anchoring, it stands ready to take timely measures to stabilise inflation around the target while supporting the economy to operate near its potential over the medium term. The next Monetary Policy Review will be announced on 20 November.