ISTANBUL: Turkey's central bank cut its main policy rate for the first time in more than a year yesterday, as falling inflation gave it room to step up its fight against a sharper-than-expected economic slowdown.

The bank lowered its policy rate, the one-week repo rate which had been on hold since August 2011, by 25 basis points to 5.50 percent but left its overnight borrowing rate at 5 percent in a more cautious move than expected.

It also raised required reserve ratios for banks on certain forex liabilities in a bid to drain forex liquidity and prevent the lira from appreciating too sharply if speculative capital inflows increase.

It left its overnight lending rate, which it had trimmed three times since September, on hold at 9 percent.

The moves reflected efforts to balance the need to stimulate weak domestic demand against concern about a narrowing but still wide current account deficit, Turkey's main economic weakness.

"The scope for further policy easing from here will depend to a large extent on whether global risk appetite holds up," said Neil Shearing, chief emerging markets economist at London-based Capital Economics.

"Turkey's current account deficit has narrowed in recent quarters, but remains large. Meanwhile, short-term external debt is relatively high. All of this leaves the lira vulnerable in the event of a fresh global shock."

The central bank said it may adjust its rate corridor again in a measured way in the period ahead and said it was appropriate to keep rates low as capital inflows accelerate.

"The central bank's bias is toward easing, but not necessarily on the policy rate anymore ... more likely on the lower band especially if appreciation pressure on the lira strengthens," said Sengul Dagdeviren, a senior vice president at ING Bank.

Almost all of the 13 economists polled by Reuters ahead of the regular policy meeting had expected a quarter-point reduction in the policy rate, but they had also expected a cut of at least a quarter-point in the overnight borrowing rate.

The lira firmed to 1.7805 against the US dollar in response to the decision from 1.7850 beforehand.

Turkey was the fastest-growing economy in Europe last year, expanding 8.5 percent, but domestic demand has slumped and the economy slowed more than anticipated in the third quarter, registering growth of just 1.6 percent.

The slowdown has helped bring down inflation, which fell to 6.37 percent in November from above 11 percent in April.

The central bank has been trying to stoke growth by boosting liquidity since the middle of the year, but the current account deficit has meant it has been cautious not to cut too aggressively.

It has been trimming its overnight lending rate in a bid to reduce the interest rates banks charge on loans, but the slowdown in the third quarter, combined with a fall in industrial production, had suggested a need for deeper moves.

"I would characterize the decision as less aggressive than the market expected ... but there is still room for cuts," said Benoit Anne, head of emerging markets strategy at Societe Generale.

"The bank moved required reserves on forex to counteract effects on the lira. I don't think it's a turnaround in policy direction. They will cut more if needed."

Abundant and cheap global liquidity driven by low interest rates have put upward pressure on the lira, which rose to a three-month high against the dollar in early November after Fitch gave Turkey its first investment grade rating in 18 years.

Investors expect a second agency to follow suit next year, paving the way for further foreign capital to flow into the country. The central bank has said in the past it will act swiftly if the real exchange rate rises too quickly.