Move will deter speculators betting on a revaluation of the dollar-pegged currency.
Kuwait's central bank cut its repurchase rate by 12.5 basis points on Sunday after warning speculators against betting on a revaluation of the oil exporter's dollar-pegged dinar currency.
The move, four days after the bank said it may act against currency speculators, takes the repo rate to 5.75%, making it cheaper for Kuwaiti banks to borrow money for one week from the central bank.
That would put more dinars on the market, easing upward pressure on the exchange rate. It also raises the risk of inflation, a factor that prompted Kuwait, which has a tenth of the world's oil reserves, to revalue its currency last year.
"It's a catch-22 situation for Kuwait," said Steve Brice, regional head of research at Standard Chartered in Dubai, adding that concerns about inflation appeared to have prevented the central bank from making a bolder move.
"12.5 basis points is an extremely small move, and the international financial community is likely to look at this as a weak response," he said.
A central bank official said the bank had changed the repo, but declined to give reasons.
The repo cut could be the first of several measures to curb speculation, said Rafeek KP, assistant vice president, treasury, at Abu Dhabi Islamic Bank.
"It will reduce the pressure on the dinar. They may have to take other measures to reduce speculation, which has been quite intense," he said.
Investors had been buying dinar forwards after Kuwaiti officials said they may revalue the dinar, which, like other Gulf Arab currencies, is pegged to the U.S. dollar.
Kuwait, Saudi Arabia and four other Gulf Arab oil producers pegged their currencies to the dollar to prepare for monetary union in 2010.
Markets began betting on a currency revaluation last year as the dollar fell around 10% against the euro, making some Gulf imports more expensive and pushing up inflation.
Speculation grew after Oman said it would not make the 2010 deadline for a single currency, and reached fever pitch in January when the United Arab Emirates raised the prospect of a region-wide revaluation after a meeting of Gulf central bankers in Saudi Arabia this week.
Kuwait is seen as the most likely candidate for a revaluation, a Reuters poll of analysts showed earlier this month.
On Wednesday, Kuwait's central bank warned it "may take measures so that there will be no benefit from such speculative behaviour", and said it was not satisfied with an increase in the volume of dinar purchases.
Kuwait allowed its currency to appreciate 1% within a 3.5% trading band against the dollar in May, citing rising euro and other non-dollar import costs.
Kuwait's annual inflation rate rose to 4.3% in 2006, Standard Chartered estimated in a March research report. That would be its highest rate in at least five years.
The bank forecast Kuwait's inflation would fall to 3.2% in 2007.