In response to escalating inflation and the persistent depreciation of the Ugandan shilling, the Bank of Uganda convened a special Monetary Policy Committee (MPC) meeting and decided to raise the Central Bank Rate (CBR) to 10%.
Michael Atingi-Ego, the Central Bank Governor, highlighted the exacerbation of risks outlined in the monetary policy statement of February 2024, particularly the ongoing depreciation of the shilling exchange rate, as the primary catalyst for this decision.
The value of the Ugandan shilling against the U.S. dollar has been steadily declining, with recent trading sessions showing rates of Shs. 3,910 and Shs. 3,920 for buying and selling, respectively. This decline reflects broader economic challenges facing the country and hints at underlying factors affecting the currency’s stability.
The continuous weakening of the shilling, compounded by limited intervention from the Central Bank due to insufficient reserves, underscores the necessity for immediate monetary policy action.
One of the primary objectives of increasing the CBR is to curb inflation by raising the cost of borrowing, thereby reducing consumer spending and investment. This tightening of monetary policy aims to maintain price stability and alleviate inflationary pressures.
Recent inflation data for February 2024 reveals a notable uptick, with both headline and core inflation rising to 3.4% from 2.8% and 2.4% in January 2024, respectively. Factors contributing to this increase include rising service costs and energy prices, coupled with the depreciation of the shilling, which could potentially lead to a generalized increase in prices if left unchecked.
Furthermore, the depreciation of the shilling since November 2023, exacerbated by significant outflows of offshore investor funds seeking higher yields elsewhere, poses a considerable risk to inflation dynamics. This trend, if continued, could push inflation above the medium-term target of 5% by the second half of 2024.
The Central Bank also considers the global and domestic environment, including geopolitical tensions and tighter financial market conditions, as factors that could further elevate inflationary pressures.
In addition to addressing inflation concerns, the increase in the CBR aims to strengthen the Ugandan currency by attracting foreign investment. Higher interest rates make assets denominated in the local currency more appealing to foreign investors, thereby bolstering demand and supporting the shilling’s value in foreign exchange markets.
Despite the immediate need to combat inflation and stabilize the currency, the tightening of monetary policy could dampen economic growth prospects. Forecasts for future years have been revised downward, reflecting the anticipated impact of tighter monetary conditions on household incomes, consumer spending, and investment.
However, potential mitigating factors, such as activity in the oil sector and improved investor confidence following Uganda’s removal from the Grey List by the Financial Action Task Force, offer some hope for economic resilience.
In conclusion, the decision to raise the CBR to 10% underscores the Bank of Uganda’s commitment to addressing inflationary pressures and stabilizing the shilling. Moving forward, the effectiveness of this monetary policy action will hinge on both domestic and global economic developments, with risks to inflation outlook remaining elevated.
