In July reserve money was 278.4 billion rupees, indicating a growth of 10.1 percent over the previous 12-months, against a target of 279.2 billion rupees and a targeted growth of 10.1 percent.

The Central Bank said it was expecting to meet the reserve money targets for September 2008 as well. The September target has been set at 285.2 billion rupees.

The monetary authority said it was achieving reserve money targets by absorbing liquidity (sterilizing) through open market operations and allowing market interest rates to adjust.

It has a discount window giving liquidity to the banking system at 12.0 percent, but access is restricted. Policy rates have not been changed since February 2007.

It is also maintaining a tight peg with the US dollar at around 107.80 rupees. Amidst a global commodity bubble collapse, inflation imported through the peg is also declining.

"Meanwhile, pressures on the price level emanating from international commodity prices have further moderated," the Central Bank said.

Inflation measured by the Colombo Consumer Price Index has fallen to 24.9 percent in August from 28.2 percent in June.

"This decrease could be attributed mainly to improved domestic supply conditions in relation to food and the resulting decline in prices of food items as well as the containment of demand pressures through monetary policy," the Central Bank said.

"The moderation in demand pressures is evidenced by the steady deceleration in broad money supply growth which is to be continued with the achievement of the recently revised tighter reserve money targets, further decelerating demand pressures in the future."

"These favourable developments on both demand and supply sides are likely to shape inflation expectations also so as to contain inflation further," the Central Bank said.

"Given the above discussed improvements on both the supply side and the demand side, prices are expected to further decelerate in the near term."

While the current monetary policy framework is bringing good results economic analysts have cautioned that in the context of maintaining a peg to the US dollar, reserve money targeting could have unnecessarily hurt economic activity when inflows of net balance of payments are sterilized.

Sterilizing liquidity from externally generated sources would squeeze the domestic money supply and push up external reserves, depriving capital to the local economy by taking away loanable reserves of the banking system.

Analysts say this creates a need for a more effective monetary policy framework in the future. The next monetary policy statement is due on October 2008.