A severe cost of living is expected to suppress consumer demand in 2026, keeping inflation well below the Central Bank’s target range, according to a new analysis by First Capital Research (FCR).

While the Central Bank anticipates inflation stabilizing around its 5 percent target by mid-2026, FCR projects it will average just 2.8 percent for the year, highlighting a gap between official policy expectations and actual economic conditions driven by “demand destruction.”

Despite government forecasts of strong growth, households are struggling with high living costs that have eroded disposable income. Although inflation ticked up to 2.1 percent in October 2025 due to tariff reversals, consumer demand remains weak.

FCR notes that “market strength is outpacing underlying economic momentum” and warns that slower investment and a softening SME sector may limit GDP growth to 3–4 percent in 2026, dampening demand-driven inflation.

This low-inflation environment poses challenges for monetary policy. Since the Central Bank transitioned to a single policy interest rate mechanism in late 2024, the Overnight Policy Rate has been kept at 7.75 percent. If inflation remains at 2.8 percent, the real interest rate could rise to nearly 5 percent, potentially constraining borrowing and investment, and increasing pressure for rate cuts later in the year.

Adding to household pressure, the Sri Lankan rupee is projected to weaken, reaching Rs.307.8 against the US dollar by November 2025. This depreciation is expected to raise import costs and reduce household purchasing power, further suppressing discretionary spending.