COLOMBO - Sri Lanka will relax its currency band from next week, its central bank said on Friday, as part of efforts to move towards a market-determined exchange rate as it seeks to secure a $2.9 billion bailout from the International Monetary Fund.

The central bank also raised interest rates by 100 basis points to tackle inflation now running at 50% as the country endures its worst financial crisis since independence from Britain in 1948.

The currency band was widened earlier on Friday to 10 rupees either side of the spot rate, from 7.50 rupees previously, but Central Bank Governor P. Nandalal Weerasinghe said guidance on the currency band would be removed from next Tuesday.

The central bank has been fixing the spot rate daily but did not say whether it would continue to do so after Tuesday.

"The central bank has seen gradual improvement in the forex liquidity in the banking sector. We are careful to contain excessive volatility," Weerasinghe said, adding that the central bank purchased $308 million to maintain exchange rates within the corridor mandated by the monetary authority.

"The central bank now has the capacity to rebuild reserves while minimizing forex market intervention."

The central bank raised interest rates by 100bps, pushing its standing deposit facility rate and standing lending facility rate, to 15.50% and 16.50% respectively.

Sri Lanka is awaiting approval for the IMF bailout package after seeing economic growth shrink by an estimated 9.2% last year amid soaring inflation that hit 50% last month.

The central bank will also next week suspend a mandatory directive given to commercial banks to convert 15% of all dollar earnings, the central bank chief said.

Sri Lanka's reserves were at $2.1 billion at the end of January.

(Reporting by Uditha Jayasinghe; Editing by Susan Fenton)