* Cuts by bigger-than-expected 150 bps, divides analysts
* Shilling weakens after the rate cut
* Risks remain to prices, fx stability (Rewrites throughout)
By Duncan Miriri
NAIROBI, July 5 (Reuters) - Kenya's central bank declared a measure of victory over high inflation and currency volatility after a months-long battle, cutting its benchmark lending rate by a bigger-than-expected one and a half percentage points.
While a sharper-than-forecast fall in inflation last month offered scope for a rate cut, particularly after disappointing first quarter growth figures, the bank was left balancing the need to spur output and protect a still vulnerable currency.
The regulator came under fire last year for sacrificing the currency and prices at the altar of economic growth, when soaring inflation and currency turmoil engulfed the region. It atoned in the final quarter of 2012 when it jacked up rates.
The Monetary Policy Committee on Thursday cut the central bank rate by 150 basis points to 16.5 percent, saying its tightening stance had worked to cool inflation and stabilise the shilling.
"The Committee noted that the implementation of its monetary policy framework is working," it said in a statement, citing falling inflation, foreign exchange rate stability and improved hard currency reserves position.
Year-on-year inflation fell for the seventh straight month in June to 10.05 percent from 12.22 percent in May.
However, the MPC warned of lingering threats to prices and currency stability, mainly due to a current account deficit, which it said was still high in May at 11.3 percent of GDP.
Economic growth slowed to 3.5 percent in the first quarter of this year from 5.1 percent a year ago - the slowest first quarter growth since 2008 - as high commercial lending rates hit business like the key construction sector.
"We sit on the cusp of an easing cycle which will total about 600 basis points through year-end, and the MPC whilst re-establishing their inflation-busting credentials, are also making sure the slow down does not run away from them," said Aly Khan Satchu, an independent trader and analyst.
Some analysts cautioned the policymakers risked undermining the shilling with larger-than-expected cuts.
"The 150 basis points cut was slightly larger than consensus expectations for a 100 basis points cut and could thus move the Kenyan shilling somewhat on expectations that the CBK will cut rates at sharper increments than expected," said Mark Bohlund, senior economist at IHS Global Insight in London.
The MPC said it would revert to bi-monthly policy meetings, shifting from monthly meetings which were adopted late last year at the height of the inflation and currency crisis.
"Reverting back to bi-monthly meetings could prompt fears that the central bank is 'taking the eye off the ball' amid what are still very uncertain circumstances both domestically and globally," Bohlund said.
The shilling weakened to 84.7 per dollar in after-hours trading, from 84.25 per dollar before the decision, Reuters data showed.
Still, other analysts said the move to cut rates boldly would not harm the shilling, citing the central bank's continuous open market operations.
"It would be wrong to see this rate move as KES-negative in any way. Real interest rates remain substantial in Kenya, and may increase ahead of the September MPC meeting, as inflation continues to decelerate," said Razia Khan, head of Africa research at Standard Chartered. (Additional reporting by Beatrice Gachenge and Kevin Mwanza; Editing by Richard Lough)