Food prices push point to point inflation to 5.8% in September 2010

Point to point inflation, as measured by the Colombo Consumer Price Index (CCPI - base year of 2002), rose to 5.8% in September 2010 (from 5.0% in August 2010), in line with our expectations, while annual average inflation rose to 5.0% (from 4.5% in August). The CCPI rose 1.0% MoM to 220.7 points, the highest monthly increase since May 2010.

Meanwhile, point to point inflation as measured by the CCPI core index (which excludes the more volatile food and energy items of the CCPI) rose to 5.7% in September 2010, while annual average core inflation remained unchanged for the fourth consecutive month at 6.3%.

The rise in the index in September was due to the key Food sub-index (46.7% of the index) rising 1.7% MoM mainly due to a rise in the prices of fish and seafood, coconuts, fruits and bread. Rice prices, however, continued to decline in September due to produce from the Yala season harvest coming into the market.

The Central Bank of Sri Lanka (CBSL) has taken a number of initiatives to relax its monetary policy over the past few quarters to stimulate economic growth.

Subsequent to a number of policy rate reductions since October 2008, and a reduction in the Statutory Reserve Ratio for the banking sector, the CBSL decided to reduce the general provision for the banking sector from 1.0% (at present) to 0.5% by end December 2011. The reduction will be implemented at a rate of 0.1% per quarter, commencing from the quarter ended 31 December 2010.

Given the index-weighting towards Food, the increase in agriculture activity (especially paddy cultivation) will help constrict a potential rise in inflation, although it is dependent on the vagaries of the weather patterns.

The Government has sought to control external shocks to the economy too, with retail petroleum prices for example changing only slightly since December 2008, despite significant crude oil price volatility.

Hence, we expect inflation to remain stable in the medium term, and maintain our forecast for point to point and annual average inflation at 5.7% each in 2010E, and 8.2% and 7.5% in 2011E.  (Source: C T Smith Stockbrokers Pvt. Ltd.)