By Uditha Jayasinghe
COLOMBO, Aug 11 (Reuters) - Sri Lanka's central bank sees no need for more interest rate hikes this year after its unexpected raise in May, with inflation expected to peak around current levels before easing next year, but said it will be vigilant for any surprises, Governor P. Nandalal Weerasinghe told Reuters on Tuesday.
Sri Lanka's central bank surprised the markets with a 100 basis-point hike in May, its first increase in more than three years, to contain inflation fueled by
the Iran war.
Weerasinghe said the May hike was a "proactive" move taken because the central bank expected inflation to rise to 7%, and current inflation was broadly on expected lines.
"We need to monitor ... whether there will be any deviation from what we thought," he said.
"Any decision going forward for us to tighten or loosen will be based on whether we are going to see a realisation of a deviated path from what was initially expected. So far, we have not seen (that)."
Sri Lanka's key inflation index climbed to 7.3% in July, marking the biggest rate of increase in three years, driven by rising energy prices. Some analysts expect the inflation rate to climb to 8% in November.
Weerasinghe said that the full impact of the May rate increase would take 12 to 18 months to work through the economy and that inflation was likely to return to the central bank's 5% target in the first half of next year.
"Multiple actions are needed to anchor inflation expectations and have a credible policy so that we are giving the assurance that inflation will be brought back to 5% going through," the governor said.
The latest comments from Weerasinghe, who wants to rein in inflation without derailing growth, suggest the central bank is ready to keep monetary policy steady at 8.75% at least for the rest of the year. The central bank's next interest rate announcement will be on September 30.
Analysts said the move in May put at risk the fragile, IMF-backed recovery taking hold in the economy.
Like most energy-importing nations, Sri Lanka has been hit by high crude prices due to the U.S.-Israeli war on Iran that began on February 28 and which has choked key oil and liquefied natural gas supply routes, leading to a surge in global crude prices.
Sri Lanka's government has raised fuel prices by more than 35%, introduced rationing and declared Wednesdays a public holiday as it looks to cushion the blow on the government's books.
GROWTH FEARS
Sri Lanka's economy grew by 5% in 2024 and 2025, posting a strong recovery from a financial crisis in 2022 when the economy contracted by 7.3%.
The island nation had expected similar growth in 2026, too, but measures to defend the economy against global headwinds could eventually lead to lower growth, analysts have said.
But Weerasinghe justified his hawkish stance by saying "low inflation is a necessary condition for future growth," and said he expected growth to be in the 4%-5% range.
The International Monetary Fund backed the central bank's rate hike and agreed to release $695 million of its $2.9 billion program, predicting Sri Lanka could still grow by 3% this year.
Maintaining a steady build-up in foreign exchange reserves remains a key priority for the governor as rising fuel import costs threaten to put fresh pressure on Sri Lanka's external accounts.
Weerasinghe aims to boost the central bank's gross foreign exchange reserves to about $8 billion by the end of the year from roughly $6.6 billion now, as the authorities continue to rebuild their external buffers.
(Reporting by Uditha Jayasinghe; Editing by Aftab Ahmed and Hugh Lawson)
