Why Bangladesh Bank Should Think Twice Before Cutting Rates
The Core Issue: A Delicate Balance in Monetary Policy
Bangladesh Bank is facing a crucial decision as it prepares to announce its Monetary Policy Statement for the upcoming fiscal year. The question on everyone's mind is whether to cut the policy rate and ease monetary conditions, a move that could have significant implications for the country's economic trajectory.
The Pressure to Cut Rates
The pressure to ease monetary policy is understandable. Headline inflation has decreased from its peak, the real policy rate is positive, and private investment remains subdued. Business groups are advocating for cheaper credit, making a rate cut seem like the obvious and politically appealing next step.
However, a closer examination of inflation dynamics in Bangladesh reveals a more complex picture. By analyzing monthly data from July 2019 to October 2025, we can uncover the underlying factors driving inflation and the potential consequences of rate cuts.
Persistent Food Inflation: The Upstream Driver
At the heart of Bangladesh's inflationary challenges is persistent food inflation. Unlike explosive inflation, which rises rapidly and then stabilizes, Bangladesh's food inflation tends to remain elevated for extended periods, eroding household purchasing power. This is primarily due to the inertial nature of food prices, which adjust asymmetrically to shocks.
Food prices rise quickly in response to supply disruptions, policy frictions, or global price movements but fall back only slowly when conditions improve. Moreover, food inflation appears largely insulated from standard macroeconomic levers, such as domestic credit growth, broad money growth, or exchange-rate movements. Instead, it is best explained by its own past, unwinding only gradually over time.
Non-Food Inflation: The Spreading Effect
Non-food inflation plays a crucial role in how shocks spread across the economy. While less persistent than food inflation, non-food inflation is more responsive to macroeconomic conditions, particularly exchange-rate movements. A 1% depreciation of the taka can raise non-food inflation by about 0.15 percentage points within a few months, a significant and relatively quick pass-through effect.
This dynamic explains why inflation in Bangladesh rises quickly and broadly but falls slowly and unevenly. Even after exchange-rate pressures stabilize and non-food inflation begins to ease, headline inflation remains elevated until food prices finally turn.
Implications for Monetary Policy
These dynamics imply a different role for monetary policy in Bangladesh than the one embedded in standard demand-based frameworks. In conventional models, core inflation (typically defined as CPI excluding food and energy) is treated as a proxy for excess demand, with rising core inflation signaling overheating and falling core inflation suggesting that tighter policy is cooling demand.
However, this interpretation does not fit the Bangladeshi data. Demand-mediated monetary transmission, where tighter policy lowers inflation by cooling domestic spending, appears weak or absent. Instead, monetary conditions influence inflation primarily through the external sector, with easier credit and lower interest rates raising demand for imports and increasing pressure on the taka.
The Decision at Hand
The upcoming Monetary Policy Statement will be judged on whether Bangladesh Bank chooses to ease or hold steady. The evidence suggests that cutting rates now would be premature, as it risks weakening the exchange rate, reigniting inflation, and prolonging the disinflation process.
While monetary policy alone cannot fix food inflation, Bangladesh Bank can still influence food price dynamics by improving contestability in food markets. This can be achieved by reducing non-price frictions in foreign-exchange and trade finance, including clearer and more predictable rules for authorized banks to open import letters of credit for essential food items and lowering discretionary barriers that allow supply to be restricted.
A Credible Path to Sustained Disinflation
By staying the course and supporting currency stability while improving food market contestability, Bangladesh Bank can offer a more credible path to sustained disinflation. This approach avoids the risks associated with premature easing in the current inflation regime, ensuring a more stable and predictable economic environment for the country's long-term growth.
