BB’s policy rate cut decision: Anchoring inflation expectations remains the missing piece in monetary policy

The Bangladesh Bank has started lowering the policy rate, shifting away from its previous tight monetary policy stance. The move reflects concern that high borrowing costs have discouraged private investment, slowed credit growth, and weakened job creation. Businesses have long argued that lending rates of 14% to 15% have made many investment projects financially unviable.

Yet the debate has largely centred on whether lower interest rates will stimulate investment. Far less attention has been given to a more important question: Have inflation expectations fallen enough to justify easing? 

Monetary policy affects the economy not only through borrowing costs, but also through what households, businesses, and financial markets expect prices to do next. If those expectations remain elevated, lower rates may do little to restore price stability while weakening the central bank's credibility.

Bangladesh's inflation problem is not merely a monetary phenomenon. It reflects deep-rooted structural weaknesses that interest-rate policy alone cannot fix. Exchange-rate depreciation, imported inflation, higher energy prices, weak market competition, broken supply chains, governance failures, and politically connected extortion have steadily driven up business costs, with the burden ultimately falling on consumers.

But after several years of persistently high inflation, the problem is no longer just structural. Inflation expectations have become a powerful force in their own right. Yet Bangladesh Bank has paid too little attention to this reality. 

As households and businesses increasingly expect prices to keep rising, those expectations become embedded in wage-setting, pricing, and everyday economic decisions, making inflation more persistent. By failing to recognise and address this shift sooner, the Bangladesh Bank bears part of the responsibility for allowing inflation to become so deeply entrenched.

Why inflation expectations matter

Inflation expectations are the beliefs people form about future prices. They matter because people do not wait passively for prices to rise; they act on what they expect next. If a wholesaler expects import costs to rise, he raises prices before they increase. If a retailer expects the next shipment to cost more, she adjusts today's prices. If a family believes rice or cooking oil will become more expensive next week, it buys sooner than planned.

This is how expectations become part of inflation itself. The initial shock may come from exchange-rate depreciation, higher fuel prices, or supply disruptions. But once people begin expecting higher prices, they start behaving in ways that reinforce inflation. Inflation expectations are therefore not just an abstract concept for economists. They are one of the channels through which inflation persists even after the original shocks begin to fade.

That is why modern central banking is as much about managing expectations as it is about changing interest rates. A credible central bank convinces the public that inflation will eventually return to a low and stable level. Without that credibility, high inflation gradually becomes the new normal, making it much harder to bring down.

How Bangladesh's informal markets shape inflation expectations

The way inflation expectations spread in Bangladesh is very different from the way they spread in many advanced economies. In developed countries, people often form expectations from official inflation data, financial news, or central bank communication. In Bangladesh, however, a large share of economic activity still takes place in informal markets where prices are negotiated rather than fixed. As a result, expectations are shaped as much by everyday experience as by official information.

Almost every Bangladeshi has heard some version of the same conversation. For instance, a customer in a grocery store will ask why rice, vegetables, or cooking oil have become so costly. A passenger might haggle with the rickshaw puller about the fare. Even a beggar who receives a small amount of taka might complain that the money is no longer sufficient to buy anything. 

Although these conversations may seem ordinary, they are important from an economic point of view since they all convey the same message — that everything is becoming more expensive.

The real worry is that monetary easing started before inflation expectations stabilised. It could signal that the battle against inflation is already over if the policy rate is lowered while inflation remains high.

At first glance, these exchanges seem like ordinary complaints about the rising cost of living. But they also transmit information. Every time people hear that prices are rising, it shapes their expectations about future inflation. Hearing the same message repeatedly — in grocery stores, vegetable and fish markets, tea stalls, buses, rickshaws, and neighbourhood shops — gradually reinforces the belief that prices will continue rising.

Those expectations in turn affect the following transaction. For example, a vegetable seller increases today's price since he anticipates that wholesale prices will go up tomorrow. A rickshaw puller asks for a higher fare because he thinks that food prices will keep rising. A grocery shop changes its prices before refilling its stock because it expects suppliers to charge more. Consumers buy rice, cooking oil, and other necessities earlier than they had intended because they are worried about having to pay more next week.

These actions do not create inflation on their own. Inflation usually begins with shocks such as exchange-rate depreciation, higher import costs, rising energy prices, or supply disruptions. But in an economy where millions of prices are determined through bargaining rather than fixed contracts, everyday conversations become an important and often overlooked channel through which inflation expectations spread. Those expectations can reinforce inflation long after the original shocks fade.

Unfortunately, Bangladesh has very little publicly available evidence on household or business inflation expectations. Even so, anyone visiting a local market can observe how expectations spread from one conversation to another. Once inflation becomes the dominant topic of everyday discussion, it begins shaping the pricing decisions of millions of buyers and sellers.

Why the policy rate cut deserves caution

Inflation is still above 9% and food prices are continuing to put a strain on household budgets. More significant still is the fact that the primary causes of inflation have not vanished. Uncertainty about the exchange rate still exists, imported food and energy prices remain exposed, and the domestic markets are still affected by supply bottlenecks and weak competition. In such a situation it is hard to say that inflation expectations have been firmly anchored.

That is why one should exercise caution about Bangladesh Bank's recent policy decision. The problem is not that a 50-basis-point rate cut will immediately cause another spike in inflation. The real worry is that monetary easing started before inflation expectations stabilized. It could signal that the battle against inflation is already over if the policy rate is lowered while inflation remains high.

That signal matters. If businesses interpret monetary easing as a sign that price stability is no longer the central bank's top priority, they may become more willing to raise prices in anticipation of future costs. In Bangladesh's informal markets, where information spreads rapidly through everyday bargaining and conversations, such expectations can quickly reinforce inflation.

The greatest risk, therefore, is not the rate cut itself. It is that inflation expectations, once strengthened, become much harder to reverse. Central banks lose credibility not simply by lowering interest rates, but by allowing the public to question their commitment to price stability.

The real challenge is restoring confidence

Bangladesh will still have to deal with pressures related to the exchange rate, inflation caused by imports, changes in energy prices, disruptions to the supply chain, and failures in governance. These structural weaknesses are very unlikely to vanish in the near future.

Bangladesh Bank cannot eliminate these structural shocks. Its responsibility is to prevent them from turning into persistent inflation. That requires more than setting the right interest rate. It requires convincing businesses and households that inflation will continue to decline.

The success of the recent policy-rate cut should therefore be judged not only by whether lending rates fall or private investment recovers, but also by whether inflation expectations remain firmly anchored. If monetary easing begins before that confidence has been restored, today's structural shocks may become tomorrow's persistent inflation.

The real question is not whether the policy rate is 50 basis points too high or too low. It is whether Bangladesh Bank is doing enough to convince the public that inflation will not become the country's new normal.

The author is an Associate Professor of Economics at Texas State University. He can be reached at iahmed.eco@gmail.com