Sri Lanka's cenbank sees inflation peak above target in Q2 next year

COLOMBO (Reuters) - Sri Lanka's headline inflation is expected to peak around 2 percentage points above the central bank's target in the second quarter of 2026, the bank said in a monetary policy report on Friday.

The comments come after the Central Bank of Sri Lanka took advantage of a steep decline in inflation to slash policy rates by 125 bps last year, as the island nation focuses on a robust rebound from a severe financial crisis.

"While headline inflation may edge above the target between late 2025 and mid-2026, projections indicate that this deviation will be short-lived," the bank said in its report.

It attributed the increase to an unfavourable base effect, a faster increase in global food inflation and demand pressures.

Sri Lanka's inflation stood at minus 4% in January, having tumbled from a peak of 70% in September 2022, mainly due to a reduction of a fifth in power tariffs.

It is expected to accelerate and approach the central bank's target of 5% in the third quarter of 2025 and rise further afterwards, the bank said.

Economic growth in the final quarter of fiscal 2024 is expected to be robust, driven by healthy industry activity, the bank said, with annual growth projected at about 5%. The economy contracted 2.3% in 2023.

In his first full-year budget on Monday, President Anura Kumara Dissanayake will lay out the government's revenue and policy goals, as it seeks to extend the crisis recovery, and signal alignment with a $2.9-billion IMF bailout program.

A severe drain in dollar reserves plunged the Indian Ocean island into turmoil three years ago, sent inflation soaring, depreciating the currency and forcing a $25-billion foreign debt default.

The central bank report also projected a marginal current account deficit for 2025, mainly driven by an anticipated higher trade deficit, as vehicle imports resume.

(Reporting by Uditha Jayasinghe and Chris Thomas; Editing by Clarence Fernandez)