Revvy Weekly · Issue 1 · 19 October 2026
Sri Lanka holds its interest rate as energy prices push inflation to 8%
The central bank raised its main rate in May, then held it in September while inflation kept rising. Was raising the rate the right response?
- Edexcel IAL Economics
- Unit 2 (WEC12)
- Sri Lanka
- Inflation and interest rates
- Read the extract.
- Write your answer to each question. Write first, then mark yourself.
- Read the model answer and see which marks you missed.
- In May 2026, the Central Bank of Sri Lanka raised its main interest rate, the Overnight Policy Rate, by 1 percentage point to 8.75%. Inflation had reached 5.4% in April, above its target of 5%. The bank said that uncertainty over tensions in the Middle East had kept world oil prices high, which had pushed up Sri Lanka's energy prices. It warned that this could spread to other prices, and that people's expectations of inflation could drift away from the target. It also said private sector lending kept growing, increasing demand for imports. The rupee had been at risk of losing value, but this had eased somewhat.
- Inflation kept rising. In August it reached 8.0%, and the bank said this reflected the sudden rise in energy prices spreading through the economy. In September, the bank kept the rate at 8.75%. It said that lending was now growing more slowly, and that expectations of inflation over the medium term were still broadly in line with the 5% target. It expects inflation to stay high through the first quarter of 2027, before easing towards 5%. The bank said it is ready to act if price rises get stronger, or if expectations start to drift.
- Real GDP was 4.7% higher in the first half of 2026 than a year earlier. On 1 October, the government and the central bank set the inflation target at 5% for the next three years. The target is for inflation averaged over each three-month quarter. The margin of 2 percentage points on either side marks 3% and 7%.
| Measure | Figure |
|---|---|
| Overnight Policy Rate, since May 2026 | 8.75% |
| Headline inflation, April 2026 | 5.4% |
| Headline inflation, August 2026 | 8.0% |
| Real GDP growth, first half of 2026 (compared with a year earlier) | 4.7% |
| Inflation target, with the margin on either side | 5%, with a margin to 3% and 7% |
Source: Central Bank of Sri Lanka, May, September and October 2026. Inflation is measured with the Colombo Consumer Price Index.
Question 1
Analyse how higher energy prices could have contributed to the rise in Sri Lanka's inflation rate shown in the extract.
When you mark it, you’ll see what earns the marks and a model answer.
Question 2
Discuss whether raising the Overnight Policy Rate was the best way for the Central Bank of Sri Lanka to respond to rising inflation.
When you mark it, you’ll see what earns the marks and a model answer.
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Words in the extract
- Overnight Policy Rate
- The interest rate the central bank sets to guide other interest rates in the economy.
- headline inflation
- The rise in the prices of all goods and services over 12 months, including energy and food.
- percentage point
- The gap between two percentages. A move from 2% to 3% is a rise of 1 percentage point.
- real GDP
- The value of all goods and services made in a country, after removing the effect of price rises.
- expectations of inflation
- What people think inflation will be in the future.
- medium term
- A period of a few years, not just the next few months.
Stuck? Revise these first
Where the facts come from
- The Central Bank of Sri Lanka maintains the policy rate at the current level (Monetary Policy Review No. 5 of 2026) (Central Bank of Sri Lanka, 30 September 2026)
- The Central Bank of Sri Lanka increases the Overnight Policy Rate (Monetary Policy Review No. 3 of 2026) (Central Bank of Sri Lanka, 26 May 2026)
- Sri Lanka's Inflation Target is set at 5% for the next three years (Central Bank of Sri Lanka, 2 October 2026)
The extract is written in our own words from these pages. Facts as of 30 September 2026, checked on 11 October 2026.