By Uditha Jayasinghe and Swati Bhat
COLOMBO (Reuters) -Sri Lanka's central bank raised interest rates on Friday to tackle inflation and said it would relax its currency band to move towards a market-determined exchange rate as it seeks to secure a bailout from the International Monetary Fund.
The bank raised its standing deposit facility rate and standing lending facility rate by 100 basis points each to 15.50% and 16.50%, respectively, it said in a statement.
The country is awaiting approval of a $2.9 billion IMF bailout package as it endures its worst financial crisis since independence from Britain in 1948.
Central bank Governor P. Nandalal Weerasinghe said with the rate increase all "prior actions" have been fulfilled and he was hopeful of the IMF bailout being approved within this month.
Despite the increase in rates, the central bank expects market rates will continue to reduce, while on the currency front the country will gradually move towards a market-driven exchange rate regime, Weerasinghe added.
To that end, he said guidance on the currency band would be removed from next Tuesday. The bank has been gradually widening the band throughout this week, to 10 rupees either side of the spot rate for Friday.
The island nation's economy has been squeezed by the financial crisis, with growth contracting by an estimated 9.2% last year amid soaring inflation that hit 50% in February.
The central bank raised rates by a record 950 basis points last year to tame inflation and then kept them steady until Friday's 100 basis point increase.
"There have been some differences between the CBSL and IMF staff on the inflation outlook," the Central Bank of Sri Lanka (CBSL) said in its statement.
"Given the necessity of fulfilling all the 'prior actions' in order to move forward with the finalisation of the IMF Extended Fund Facility (EFF) arrangement, the Monetary Board and the IMF staff reached consensus to raise the policy interest rates," it added.
Sri Lanka has to restructure its debt before IMF disbursements can begin.
"It indicates that the IMF staff are pushing to complete any and all possible domestic actions, hoping they can convince IMF board for approval of the program," Thilina Panduwawala, head of research at Colombo-based Frontier Research, said.
"It will probably leave the market confused in the near term than confident. But depends on whether the market reads this as positive for getting IMF (bailout) in March."
Sri Lanka is seeking IMF approval under a special Lending Into Official Arrears policy, which allows the global lender to green-light the program without formal prior financing assurances from China, Weerasinghe said.
India and the Paris Club of creditors, the island nation's other major lenders have already given their support.