Sept. 11 (Bloomberg) -- Sri Lanka’s central bank cut its benchmark interest rates to a three-year low to help support the South Asian island nation’s economic recovery after the end of its three-decade civil war.

The Central Bank of Sri Lanka lowered the reverse repurchase rate to 10.5 percent from 11 percent, according to a statement on the Colombo-based bank’s Web site today. That’s the lowest since August 2006. The repurchase rate was lowered to 8 percent from 8.5 percent.

Lower borrowing costs and government spending to rebuild roads, schools and hospitals in areas formerly controlled by the separatist Tamil Tiger rebels prompted the central bank in July to raise its economic growth forecast to as much as 4.5 percent from 2.5 percent.

"Cutting rates will be better for economic prospects and make it more attractive for foreign investment to come in," said Bimanee Meepagala, an analyst at Eagle NDB Fund Management Co. in Colombo. "Inflation will be at manageable levels."

Today’s reduction should prompt commercial banks to cut lending rates and help boost consumer spending and encourage companies to borrow, the central bank said in the statement.

"Today’s decision by the central bank to further reduce its policy interest rates would signal to the market the need for further reductions in market interest rates and expansion in credit to the private sector," the bank said.

Tigers of Tamil Eelam

To boost spending, the government is aiming to raise $500 million from dollar-denominated sovereign bonds in overseas markets in October to help fund reconstruction.

A $2.6 billion loan approved in July by the International Monetary Fund and improved investor confidence after government troops defeated Liberation Tigers of Tamil Eelam rebels in May have helped attract foreign investment and eased local borrowing costs, the central bank said July 23.

Consumer prices in the capital, Colombo, rose 0.9 percent in August from a year earlier after gaining 1.1 percent in July.

Inflation would "gradually rise to moderate levels in the approaching months" even as it remains at low single- digit levels through to the end of 2010, the central bank said today.

Cabraal, who forecast 2009 inflation of 5 percent, last month said there was still room to cut interest rates after three reductions earlier this year.

The central bank wants lenders to cut borrowing costs before it lowers its key rates further, he said at the time.