The Central Bank of Sri Lanka (CBSL) sees no need for more interest rate increases this year after its big, unexpected hike in May, with inflation expected to peak around current levels before easing back towards the 5 per cent target next year, Governor P. Nandalal Weerasinghe told Reuters on Tuesday.

The 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. Analysts said the move put at risk the fragile, IMF-backed recovery taking hold in the economy.

Governor Weerasinghe said the May hike was a "proactive" move taken because the central bank expected inflation to rise to 7 per cent, 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 per cent 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 per cent in November. 

Governor 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 per cent target in the first half of next year.

The latest comments from Governor Weerasinghe, who wants to rein in inflation without derailing growth, suggest the Central Bank is ready to keep monetary policy steady at 8.75 per cent at least for the rest of the year. The Central Bank's next interest rate announcement will be on September 30.

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.

The government has raised fuel prices by more than 35 per cent, 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 per cent in 2024 and 2025, posting a strong recovery from a financial crisis in 2022 when the economy contracted by 7.3 per cent. 

Sri Lanka 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 Governor 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 per cent-5 per cent 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 per cent 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. 

Governor 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.

– with Agencies inputs --