FY26 monetary policy: To ease when is the question

Highlights:

• Inflation is easing but remains above Bangladesh Bank's target
• Growth is recovering slowly; labour market remains weak
• Investment and credit growth are historically low, confidence subdued
• Currency stabilised; banking sector still faces major challenges
• BB signals shift from disinflation focus to growth support
• Policy rate remains high; premature easing risks renewed inflation

Bangladesh Bank (BB) is in the final stages of framing its monetary policy stance for FY26 – a process anchored firmly in the interpretation of economic indicators spanning inflation, exchange rates, interest rates, growth, investment, liquidity, employment, wages, and beyond.

At the heart of this deliberation lies the pivotal question: when, if at all, should the monetary policy rate be eased? Is now the moment, or does prudence call for patience?

The state of play

Inflation is cooling but its heat has remained scorching. In June, year-on-year headline inflation eased to 8.5% – marking the third consecutive monthly decline – as both food and nonfood inflation subsided across rural and urban areas. Still, inflation is well above BB's sub-6% target. On a month-to-month basis, prices in June rose at a brisk 7% annualised pace. BB's estimate of core inflation that excludes food and energy stood at nearly 9% year-on-year and 10.2% on a 12-month moving average basis in June. 

The worst of the growth slowdown may be behind us. Quarterly GDP figures up to the third quarter of FY25 – when inflation was running above 10% – paint a picture of industry-led resurgence: from a trough of 1.81% in the first quarter to 4.86% by the third. BBS has provisionally estimated 4% real growth for FY25, marginally lower than the 4.2% final estimate for FY24.  

The labour market is depressed. The employed labour force as a share of the working age population was 55.9% in the last quarter of 2024, below the 59.6% peak attained in the 4th quarter of 2022. Real wages have continued to decline.  Simultaneous decline in real wages and the employment rate in the last eight quarters indicates a secular decline in labour demand, attributable presumably to structural reasons.

One such reason is entrepreneurial vigour, which is subdued. Import settlements and letters of credit for capital machinery are still weak, and private credit expansion has dwindled to historic lows. Primary energy shortages continue to bite. Confrontational politics adds salt to injured animal spirits.

The financial environment is showing signs of improvement: the currency has stabilised, foreign reserves are on the rise, and the backlog of foreign exchange arrears has been largely cleared. However, persistent distress continues to cloud the banking sector, tempering the optimism engendered by these gains and the ongoing banking reform efforts.

Changing priorities?

BB's previously unwavering commitment to disinflation now appears to be softening. This shift became apparent on 13 July, when the BB purchased $170 million from commercial banks. The aim was to prevent the taka from appreciating beyond Tk121.5 to the dollar – a threshold said to align with the Real Effective Exchange Rate (REER). However, it's worth noting that because most of Bangladesh's trade is conducted in US dollars, conventional measures of the REER may not fully reflect the country's actual competitiveness.

Intervening by purchasing USD to curb volatility would be justified only if the recent appreciation of taka threatened to undermine export and remittance growth. This scenario seems implausible, especially considering the broader context of global dollar depreciation. 

More importantly, this move raises the question of whether BB is now less willing to allow exchange rates to play their natural role in containing inflation, even though the exchange rate remains among the most powerful levers influencing inflation in Bangladesh.

Yet another softening signal came from the widening of the money market Interest Rate Corridor (IRC) from 16 June. BB has reduced the rate on its Standing Deposit Facility from 8.5% to 8%. With the rate on the Standing Lending Facility unchanged at 11.5%, the IRC has increased from 3% to 3.5%. Other than deepening money market trade volume, this has no more than a signalling value in passing through retail rates.

Forget not the other hand

These developments indicate that BB may be inclined to place greater emphasis on stimulating growth. Whether this prioritisation proves wise depends crucially on its timing because of the evolving relationship between inflation and growth. Available data provides no clear guidance: at times, growth and inflation have moved in tandem; at others, they have diverged or shown little connection at all. This variability in our historical experience cautions against drawing broad conclusions from limited evidence.

Yet limited evidence is all we have. One such evidence is about the limits of BB's influence over retail interest rates. BB only sets the very short-term policy rate; longer-term wholesale and retail rates are shaped by government borrowing and how banks interact with customers in the deposit and lending markets. Fiscal policy plays a significant role in shaping borrowing costs for businesses and individuals. Achieving meaningful reductions in investment-relevant interest rates demands a coordinated monetary-fiscal approach that expands the pool of loanable funds available to the private sector.

This dynamic is further complicated if the taka is not permitted to strengthen past Tk121.5/$. By resisting appreciation, we risk forgoing a crucial disinflationary momentum as well as the advantageous effects on the nation's balance sheet that accrue from a stronger currency, particularly when foreign liabilities outweigh assets. When BB purchases USD, it injects additional taka liquidity into the financial system, which – if not offset – can fuel inflation and erode the nation's competitive edge.

Ease now or later?

The data certainly does not support further monetary tightening. With inflation on a downward trajectory and growth subdued, a 10% policy rate appears sufficiently restrictive. The question then is: should rates be cut now, or is it wiser to wait until evidence on getting to the 6-6.5% inflation target by end-June 2026 gets more conclusive and the economy is better poised for sustained recovery? 

Our post-pandemic experience offers little evidence of a robust link between monetary easing and real investment. The growth of gross capital formation tumbled from 11.7% in FY22 to just 2.2% in FY23, falling further to 1.8% in FY25. Private sector credit growth peaked at 12.5% in March 2022. Since then, credit growth has declined, reaching 7.2% year-on-year by May 2025. The downturn in investment set in well before private credit began to contract and interest rates began their ascent. 

When domestic political stability is fragile, economic reforms lack momentum, and global trade faces obstacles unseen since the Second World War, the impact of credit growth on investment becomes increasingly uncertain. Easing, on the other hand, carries significant inflationary risks and can expose the financial system to greater vulnerabilities.

BB's comparative advantage

BB must weigh the risks of prioritising growth against favouring inflation control. With inflation still running 250-300 basis points above BB's comfort zone, the margin for accommodating higher inflation is slim. Conversely, with growth lingering around 250 basis points below potential, there is equally little room for error on that front. BB is destined to be damned no matter which side it errs on. So, their real challenge is avoiding consequences more damning than being damned. 

Monetary policy, by its very nature, must navigate the fog of uncertainty and operate within the boundaries of what is feasible – delivering its greatest efficacy where BB's comparative strengths are clearest. This is more in the realm of inflation management than boosting growth. Easing monetary settings is likely to yield only a modest lift to growth, while amplifying inflationary pressures and reckless lending all the more. 

BB's explicit stance, as articulated in the 15 July 2025 circular regarding the IRC – which affirms that the 10% repo (policy) rate will hold steady – appears to signal a preference for maintaining elevated rates until there is more compelling evidence of a sustained decline in inflation. This approach is judicious, provided it is not compromised by overzealous efforts to prevent the appreciation of taka too much too soon.

Zahid Hussain is former chief economist of the World Bank Dhaka Office. Illustration: TBS