Bank of Uganda tightens monetary policy amid increased growth risks

The Bank of Uganda Monetary Policy Committee (MPC) has increased the April Central Bank Rate (CBR) to 10.25%, up from 10% for March 2024, citing increased risk to economic growth posed by the decline of the Uganda Shilling against the hard currencies such as the US Dollar.

The further tightening of the monetary policy, however, may lead to increase in lending rates by commercial banks while dealing a blow to investor confidence in the economy that had started picking up after the double-digit inflation caused by the Covid-19 pandemic.

The Deputy Governor, Dr Michael Atingi-Ego, on Monday said that while the Uganda Bureau of Statistics reveals a marginal decline in headline inflation to 3.3% from 3.4% in February 2024, this is not sustainable.

He explained that while the prevailing conditions of reduced aggregate demand and increasing supply are mitigating strong inflationary pressures, risks of elevated inflation persist.

“The recent CBR increase has had a spillover effect of stabilizing the shilling exchange rate. However, the shilling remains vulnerable due to outflows of short-term foreign investor funds from the domestic market in search of attractive yields in other markets and strong domestic demand by corporates. The weakening of the shilling significantly impacts domestic prices, which could push inflation higher,” the Deputy Governor explained.

He also said short-term projections indicate inflation may rise to between 5.5% and 6% within 12 months ahead, with a return to the medium-term target of 5% anticipated in the second half of 2025.

“Considering the persistent upside risks to inflation, the MPC deemed it necessary to tighten monetary policy further to anchor inflation around the medium-term target of 5%. Consequently, the CBR has been raised by 25 basis points to 10.25%.

The bands on the CBR remain at +/-2 percentage points and the margins on the CBR for the rediscount and bank rates at 3 and 4 percentage points, respectively. As a result, the rediscount and bank rates will be 13.25% and 14.25%, respectively. The increase in the CBR is a prudent measure to address the heightened inflation risks,” Dr Atingi-Ego said.

Bank of Uganda also said significant upside risks to the inflation outlook persist, including geopolitical tensions in the Middle East, potential energy price hikes, tighter global financial conditions that could lead to a stronger depreciation of the shilling exchange rate, and unfavourable weather patterns.

“On the contrary, inflation may undershoot expectations if monetary policy reduces demand more than anticipated, and global growth deteriorates sharply, resulting in lower import prices,” he said.

Nonetheless, Bank of Uganda says economic growth for FY 2023/24 is forecast at approximately 6%, and subsequent years are expected to hover between 5.5% and 6.5%.