The economy will probably expand 8 percent this year, easing slightly from an 8.3 percent growth in 2011, the central bank said, despite an expected global slowdown led by the lingering Europe debt crisis and turmoil in Middle East.

The repurchase rate was left at 7.00 percent and the reverse repurchase rate at 8.50 percent, both at their lowest in more than seven year in line with the forecasts in a Reuters poll.

It has been three years since the end of a 25-year old war that had been crippling the economy and the government has now embarked on a more-than $6 billion infrastructure drive to revitalise the war-hit economy.

"Continued development efforts aimed at improving economic and social infrastructure are expected to augment the productive capacity of the country and thereby enable the realisation of the country's growth potential," the central bank said in its monthly policy review statement.

"Improvements in infrastructure would also help eliminate supply bottlenecks, thus helping to reduce price pressures."

Annual average inflation, which was at 6.7 percent by end 2011, is expected to remain around mid-single digit levels this year, while broad money (M2b) growth is expected slow down to 15 percent from 20.6 percent in November, the bank said.

DEMAND PRESSURE

Since a 3 percent devaluation on November 21, treasury bill yields have jumped between 117-172 basis points, and the average prime-lending rate in 2011 has risen by 120 basis points despite policy rates remaining steady since January 2011.

"These moderate upward movements in interest rates are likely to exert a restraining effect on monetary aggregates, which would, in turn, help to curb the build-up of demand pressures," the Bank said.

Private sector credit growth has been hovering around a 16-year high of over 33 percent in the second half of 2011. Year-on-year growth in November was 33.5 percent compared with 33.4 percent in October and much higher than the central bank's 27 percent target by end 2011.

The bank expects it to slow to 16 percent by end-2012.

Central Bank Governor Ajith Nivard Cabraal said the bank has allowed the market to adjust to the liquidity pressure.

"We don't want to give any signal as there is no inflation pressure," Cabraal told Reuters.

Traders expect yields to rise sharply despite the steady policy rate, as the central bank is heavily intervening in the foreign exchange market by buying dollars, adding that the rise in yields will help it bring credit growth down to the desired levels.

The International Monetary Fund (IMF) in September said there is no demand pressure in the economy, but it withheld the Sri Lanka's eighth tranche of a $2.6 billion loan after the central bank failed to allow exchange rate flexibility.