Cash-strapped Sri Lanka on Thursday sharply cut interest rates for the first time since it last year crashed into its worst economic crisis, with the central bank saying the country was showing signs of recovery.

The Central Bank of Sri Lanka reduced the benchmark lending rate by 2.5 percentage points to 14 percent, a day after official data showed inflation had tumbled to 25.2 percent last month, from 35.3 in April.

It said the monetary board arrived at the decision to "ease monetary conditions in line with the faster than expected slowing of inflation."

The reduction is the first since July 2020, when rates were lowered by one percentage point.

As the economic crisis worsened, the central bank began raising rates from early 2022 with a record 7.0 percentage point hike in April last year, a week before the government defaulted on its $46 billion foreign debt.

The bankrupt nation secured an International Monetary Fund bailout in March and received the first instalment of $330 million out of a $2.9 million loan spread over four years.

The central bank said the economy was showing signs of a rebound, after a record 7.8 percent economic contraction last year as the nation faced its worst foreign exchange crisis.

Sri Lanka ran out of cash to pay for even the most essential of imports leading to shortages of food, fuel and medicines.

The then-president Gotabaya Rajapaksa, who faced allegations of mismanagement, was forced to flee the country and resign in July after months of protests.

The central bank, in its latest review of the economy, said inflation was expected to fall to single figures by the end of the year, having peaked at 69.8 percent in September with food inflation hitting nearly 100 percent.