Central Bank, amidst Middle East turbulence, retains benchmark interest rates

The Central Bank of Sri Lanka on Wednesday kept benchmark interest rates unchanged even as unrest continued in Middle East which has adversely affected fuel supplies.

The decision was made at the Monetary Policy Board on Tuesday where it was decided to maintain the Overnight Policy Rate (OPR) at the current level of 7.75 per cent.

Fuel prices have soared since the conflict erupted some weeks back.

The banking regulator said in a statement that the sharp increase in global energy prices and trade disruptions amidst heightened uncertainty due to the escalation of geopolitical tensions necessitated a significant upward adjustment in domestic energy prices.

The current low level of inflation, at 1.6 per cent (y-o-y) in February 2026, relative to the target of 5 per cent, provided sufficient space to accommodate the impact of higher energy prices and their spillovers on inflation. Given the latest available data and prevailing uncertainties, inflation is now expected to reach the target of 5 per cent in Q2-2026, earlier than previously anticipated. Inflation is projected to remain around the target thereafter, the statement said. 

The economy recorded a strong real growth of 5 per cent in 2025, despite the disruptions caused by Cyclone Ditwah towards the end of the year.

Leading economic indicators point to a strong post-Cyclone recovery during early 2026. However, spillovers from the ongoing conflict could weigh on domestic economic activity in the period ahead, should the conflict be prolonged. The external sector remained robust in the first two months of 2026, supported by stronger export earnings compared to imports, along with higher remittances and tourism earnings. Gross Official Reserves increased to US$ 7.3 billion at end February 2026 and the Central Bank purchased a substantial amount of foreign exchange from the market in the first two months of the year. However, the ongoing conflict in the Middle East poses risks to Sri Lanka’s external sector outlook, particularly through energy, tourism, trade, and remittance flows, although the overall magnitude of the impact remains uncertain.

“While the Sri Lanka rupee remained relatively stable in early 2026, some depreciation pressures were observed following the onset of the Middle East conflict, similar to the exchange rates of regional peers. The Board remains prepared to implement appropriate policy measures to ensure that inflation stabilises around the target, while supporting the economy to reach its potential,” the statement added.