Cost of living crunch to keep inflation below 3% next year
By Nishel Fernando
A crushing cost of living is expected to stifle consumer demand in 2026, keeping inflation well below the Central Bank’s target range and creating a complex environment for interest rates, according to a new analysis by First Capital Research (FCR).
While the Central Bank has guided markets to expect inflation to rebound and stabilise around its 5 percent target by mid-2026, FCR challenges this view, projecting that inflation will average just 2.8 percent throughout the year.
This underscores a significant disconnect between the official policy expectations and ground-level economic reality, driven largely by what analysts describe as “demand destruction”.
Although the government forecasts paint a picture of robust growth, the households are grappling with a high cost of living that has eroded disposable income. The report notes that while inflation has recently ticked up to 2.1 percent in October 2025, due to the tariff reversals, the underlying consumer demand remains weak.
FCR states that “market strength is outpacing underlying economic momentum” and warns that “slower investment activity and a softening SME sector” will likely drag the GDP growth down to a range of 3 to 4 percent in 2026, dampening demand-pull inflation.
This low-inflation outlook presents a complex dilemma for monetary policy. Following the transition to a single policy interest rate mechanism in late 2024, the Central Bank has maintained the Overnight Policy Rate at 7.75 percent to anchor the inflation expectations.
However, an analysis of the data suggests that if the policy rates remain unchanged while inflation languishes at 2.8 percent, the real interest rate in the economy would surge to nearly 5 percent. Such high real borrowing costs could prove restrictive for an economy trying to stimulate a “softening” business environment, potentially building pressure for rate cuts later in the year, despite the current stability forecast.
Adding to the pressure on the households is the projected movement of the exchange rate. The report highlights that the “weakening LKR is likely to raise import costs and curtail household spending power”, further compressing demand.
The FCR data indicates a depreciating trend for the rupee, which is forecast to reach Rs.307.8 against the US dollar by November 2025, with the chart trajectory suggesting continued pressure into 2026. This depreciation is expected to increase the cost of essential imports, leaving the consumers with less wallet share for discretionary spending.
END/DailyMirror/MMP/22112025
