The National Bank of Serbia (NBS) cut its key repo rate for the first time in four months on March 12  to 7.5% from 8.0%. The move was expected by market analysts following the recent approval of a €1.2bn stand-by deal with the International Monetary Fund and after annual inflation touched a historic low in January.

Previously, the NBS kept the rate unchanged at 8.0% for three months in a row after cutting it unexpectedly in November by half a percentage point, in the first rate change since last June.

The NBS said in a statement that when taking the decision its executive board was encouraged by several factors, including the ongoing fiscal consolidation and structural reforms at home and the end-February approval of the IMF deal, which helped increase investor interest in Serbia amid the ample global liquidity unleashed by the quantitative easing of the European Central Bank.

The NBS noted that the declining risk premium and the increasing demand of non-residents for Serb government securities already signal that investor interest in the country is on the rise.

"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 statement said.

The executive board expects that annual inflation will return in the target band of 2.5%-5.5% around mid-2015 as the disinflationary effects of low food production costs weaken and the government hikes administered prices. It already quickened to 0.8% in February from January's all-time low of 0.1%.

Prior to the NBS decision, analysts from Societe Generale (SG EM) said in an emailed note on March 11 that the Serbian monetary authority has "ample room for manoeuvre, in the context of the mild inflation outlook and weak growth prospects".  The economy is expected to shrink by another 0.5% in 2015 following the 1.8% contraction last year when the country was hit by the worst floods in its history.

According to the SG EM analysts, the NBS might deliver with caution a cumulative easing of 150bp of its key rate by the end of 2015 as the main factors to watch will be linked with the external rebalancing and the progress on the government's fiscal reforms. 

"With headline inflation running at 0.1% yoy and core plunging to 1.7% yoy, valuations in Serbian fixed income are the most attractive in EMEA," the analysts concluded.

The NBS' next rate-setting meeting will take place on April 9.