Bangladesh Bank cut its policy rate by 50 basis points on July 30, from 10% to 9.5%. It is the first cut in nearly six years. The Standing Lending Facility rate came down too, from 11.5% to 11%.
The Standing Deposit Facility rate stayed at 7.5%. The new rates take effect from August 2.
This signals a shift in priorities.
Inflation is not under control. Headline CPI was 9.16% in June, down from May's 9.42%, and still above the central bank's own target of 6.5-7.5%. This cut came a month after Bangladesh Bank announced a cautious, contractionary policy for the first half of the fiscal year.
A central bank does not cut rates with inflation at 9% unless something else has become more urgent. Private sector credit growth had fallen to a historic low of about 4.7%, against a 6.8% target.
Investment has stayed weak for years. Business circles have been asking for relief. The message from this cut is clear: growth now matters more than finishing the inflation fight.
That is a defensible call. It is not a free one.
Room for further cuts is limited. Global energy and shipping costs have been elevated by the ongoing conflict in the Middle East, particularly the disruption risk around the Strait of Hormuz. A policy rate cut does nothing to the price of oil or freight insurance.
Until that war ends and global commodity and shipping costs normalize, inflation is unlikely to fall meaningfully, and the space for further cuts stays thin. Anyone expecting this to be the start of a steady easing cycle should temper that expectation.
Lower interest rates increase aggregate demand. In an economy as import-dependent as Bangladesh's, higher aggregate demand shows up quickly as higher imports. This is how rate cuts are supposed to work.
The question is how that extra import demand gets absorbed. There are two options, and only one of them is sensible.
Option one: let the exchange rate adjust. A modestly weaker taka makes imports more expensive at the margin, which offsets some of the extra demand created by cheaper credit. This is the market doing what it is supposed to do.
Option two: defend the exchange rate. If Bangladesh Bank tries to hold the taka steady while cutting rates, the entire adjustment falls on reserves. Reserves that took two years of IMF support, remittance inflows and tight policy to rebuild would then be spent defending a rate the market is pushing against. We have been here before, in 2022-23, and it did not end well.
Cutting the policy rate and fixing the exchange rate at the same time is trying to have it both ways. It does not work. If Bangladesh Bank wants cheaper money at home, it needs to let the currency do some of the adjustment work abroad.
In late June, weeks before this rate cut, Bangladesh Bank reimposed a 4% cap on the spread between banks' lending and deposit rates. Average spreads had widened to 5.72%, with some banks at 7-9%. The goal was the same as the rate cut: bring down borrowing costs for businesses.
A policy rate cut works with the market. A spread cap works against it. Now that Bangladesh Bank has moved on the rate, the case for keeping the spread cap is weaker than it was a month ago.
The central bank should not run both a market-based tool and an administrative one aimed at the same problem. It is time to remove the cap and let the rate cut do the job it was designed to do.
This rate cut bets that growth needs support more than inflation needs further squeezing right now. That is a reasonable bet, but a narrow one. Further cuts depend on a war Bangladesh does not control.
The exchange rate needs room to move, not defending. And having chosen the rate as its instrument, Bangladesh Bank should now retire the spread cap rather than run two tools working at cross purposes.
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Asif Khan, CFA is the Chairman of EDGE AMC Limited and a Trustee of Panam Institute