Based on a joint assessment of financing conditions and the inflation outlook, the Governing Council judges that favourable financing conditions can be maintained with a moderately lower pace of net asset purchases under the pandemic emergency purchase programme (PEPP) than in the previous two quarters. We also confirmed our other measures, namely the level of the key ECB interest rates, our forward guidance on their likely future evolution, our purchases under the asset purchase programme (APP), our reinvestment policies and our longer-term refinancing operations, as detailed in the press release published at 13:45 today. We stand ready to adjust all of our instruments, as appropriate, to ensure that inflation stabilises at our two per cent target over the medium term. I will now outline in more detail how we see the economy and inflation developing, and then talk about our assessment of financial and monetary conditions. Economic activity The economy rebounded by 2.2 per cent in the second quarter of the year, which was more than expected. It is on track for strong growth in the third quarter. The recovery builds on the success of the vaccination campaigns in Europe, which have allowed a significant reopening of the economy. With the lifting of restrictions, the services sector is benefiting from people returning to shops and restaurants and from the rebound in travel and tourism. Manufacturing is performing strongly, even though production continues to be held back by shortages of materials and equipment.
2  BIS Review 55/2007  4. Fund managers/dealers/traders  Interbank market The tight monetary policy stance adopted by CBSL and its possible continuation would result in increased reliance by banks on the inter-bank call market. Given the self imposed limits by banks on lending to each other, if a few banks attempt to raise a large volume of funds from the inter-bank market , there could be volatility in interest rates. Banks should not often rely on a potentially volatile call money market as an alternative to mobilizing deposits or exploring other funding sources. The heavy reliance by some banks on the call money market drives short term interest rates and make borrowing costs to investors and business community to very high levels. The volatility in the call market also creates uncertainty among the businesses and that adds to inflationary expectations. Forex market Given the current account imbalances, there is a mismatch in foreign exchange inflows and outflows. Sri Lanka’s foreign exchange market is not deep enough to absorb relatively large transactions, though its size and operations have gradually increased. In such a market, huge speculative trades could be rather disturbing and they could move the exchange rate against economic fundamentals. No doubt, forex market is a key source of foreign exchange income to banks. Its price, which is the exchange rate, is determined according to demand and supply forces.