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UPDATE 1-Sri Lanka central bank keeps rates steady, says growth below potential

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COLOMBO, Feb 15 (Reuters) - Sri Lanka's central bank held interest rates steady on Thursday, saying the economy is growing below potential, a widely expected decision that comes amid fresh political uncertainty after the ruling coalition government suffered a shock defeat in local elections.

Policymaker emphasised the need to support an economy that has been beset by production disruptions due to massive intermittent floods and prolonged drought last year. Demand has also been crimped by earlier rate hikes.

Some analysts expect the central bank will cut rates at some point this year to spur growth and investment.

As widely expected, the central bank kept the standing deposit facility rate (SDFR) at 7.25 percent and standing lending facility rate (SLFR) at 8.75 percent. "The Monetary Board also noted that the economy is currently operating at a level below its potential," the central bank said in a statement.

"Nevertheless, as per the available indicators, the economy is likely to recover from the effects of adverse weather conditions in the past two years and benefit from the expected boost in external demand and foreign direct investment inflows."

The on-hold decision comes amid renewed political uncertainty after the ruling coalition government of President Maithripala Sirisena's centre-left Sri Lanka Freedom Party (SLFP) and Prime Minister Ranil Wickremesinghe's centre-right United National Party (UNP) suffered telling defeats in a local election at the weekend.

The results also has raised concerns over the future of the unity government amid pressure from the opposition parties to dissolve the parliament. The central bank has tightened monetary policy four times since December 2015 through March last year to fend off pressure on the fragile rupee and curb stubbornly high credit growth that stoked inflation.

The rupee was hit this week as investors worried about policy paralysis in the wake of the election results. It slipped to a record-low of 155.90 on Wednesday before closing at 155.40/60.

Trisha Peries, Product Head, Economic Research at Frontier Research, said the central bank statement suggests "the tightening bias is no longer there," but added that policy makers will be keeping a close eye on political developments and the recent gyrations in global financial markets.

The previous rate increases have dragged on the $81 billion economy, which grew at an annual pace of 3.7 percent in the first nine months of 2017, slowing from 4.0 percent growth in the same period of 2016.

The central bank revised down last year's economic growth to 4 percent, from its original forecast of 5 percent as demand was curbed by tight monetary and fiscal policies in line with conditions by the International Monetary Fund (IMF) for a $1.5 billion loan. Consumer inflation was up 5.8 percent in January from a year earlier, slowing from a record high of 7.8 percent hit in October.

(Reporting by Shihar Aneez and Ranga Sirilal Editing by Shri Navaratnam)

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