It is the first rate cut this year by the Bank of Serbia (NBS), which cut its rate by 150 basis points in 2014.
The central bank said last month's 1.2 billion euro stand-by agreement with the International Monetary Fund (IMF) along with consistent government budget cuts and structural reforms had helped raise the interest of investors in Serbia, resulting in a fall in the country's risk premium.
Together with inflationary expectations around the NBS' target, this had "opened up the room for monetary policy to contribute to long-term sustainable recovery of the domestic economy," NBS said.
Serbia's inflation rate rose to 0.8 percent in February from a historical low of 0.1 percent in January, mainly due to the comparison with an increase in value-added-tax, and the NBS expects inflation to return to its target range in the second half of 2015 due to its policy measures and the waning impact of low growth in administered prices and low commodity prices.
The NBS targets inflation at a midpoint of 4.5 percent in a range from 2.5 percent to 5.5 percent.
Serbia's Gross Domestic Product contracted by 1.8 percent in the fourth quarter of 2014 compared with the same 2013 quarter, the fourth consecutive quarter the economy has shrunk, but the central bank has said the economy is recovering and the impact of floods in May 2014 is wearing off.
The Bank of Serbia issued the following statement:
"After reviewing current economic developments and considering the outlook for the period ahead, the NBS Executive Board decided in its meeting today to cut the key policy rate by 0.5 percentage points, to 7.5 percent.
In making this decision, the Executive Board was guided by the fact that consistent implementation of fiscal consolidation and structural reforms at home and the recent conclusion of a precautionary SBA with the IMF have helped increase investor interest in Serbia in conditions of ample global liquidity unleashed by the ECB’s quantitative easing. The rise in investor interest is evidenced by the fall in the country risk premium and increased non-resident demand for government securities. These movements, as well as inflation expectations which have been revolving around the 4% target, have opened up the room for monetary policy to contribute to long-term sustainable recovery of the domestic economy.
The Executive Board concluded that year-on-year inflation, following a historical low in January due mainly to the high base effect caused by an increase in VAT and excise rates, began to rise towards the target tolerance band (4±1.5%) in February. Inflation is expected to return within the target tolerance band in the second half of the year, as a result of monetary policy measures and the waning effect of factors with a temporary disinflationary impact – notably low administered price growth and low prices of primary commodities in the international and domestic markets.
Movements in the key policy rate in the coming period will continue to depend primarily on the materialisation of risks in the international environment and their influence on inflation, including the effect of international and domestic prices of primary commodities on other prices, assessed the Executive Board.
The next rate-setting meeting of the Executive Board will be held on 9 April 2015."