Uganda’s Central Bank raises key interest rate by 100bps to fight inflation

Uganda is currently facing its highest inflation levels since 2012, a situation exacerbated by a weakening shilling and the rising cost of living that is putting immense pressure on the economy. In response to this challenging environment, Uganda's Central Bank took a significant step by increasing its key interest rate to 10 percent, with indications that further hikes may be on the horizon unless inflation is reined in. Alan Lwetabe, the Director of Investments at the Deposit Protection Fund in Uganda, shed light on the rationale behind this crucial decision during a recent interview with CNBC Africa. Lwetabe highlighted that the decision to raise interest rates did not come as a surprise to the market, as the Central Bank had been signaling its intention to do so for the past few months. The gradual escalation of policy rates from 6.5 percent to the current 10 percent was a deliberate effort to combat inflation, which had been fueled by factors such as drought-induced food inflation and global events like the Russian invasion of Ukraine impacting fuel and energy prices. These inflationary pressures necessitated decisive action from the Central Bank. The impact of these successive rate hikes has been felt differently by various market participants. While fixed income investors have seen positive returns, borrowers are facing the prospect of higher borrowing costs as government securities set the benchmark for lending rates. As a result, the cost of credit is expected to rise, potentially slowing down private sector borrowing and economic activity in the coming months. Despite the rate hikes, the Central Bank's target of maintaining core inflation around 5 percent remains a challenge, as current core inflation levels hover around 8.5 percent. Lwetabe expressed confidence in the Central Bank's strategy, foreseeing a gradual decline in inflation over the next six to seven months as liquidity flow through the credit channel slows down. The Central Bank's Monetary Policy Committee anticipates that core inflation will return to target levels by early 2024, paving the way for a moderation in interest rates. One significant aspect highlighted in the MPC report was the impact of currency depreciation on inflation. The depreciation of the Ugandan Shilling by 2.5 percent by September mirrored similar trends in neighboring countries like Kenya and Rwanda. The Central Bank's intervention in the foreign exchange market to manage volatility and depreciation underscores its awareness of the interplay between currency fluctuations and inflation, signaling a proactive approach to economic stability. As private sector borrowing faces challenges amidst rising interest rates, lenders are witnessing a shift in investment preferences towards government securities, attracted by the lucrative yields they offer. This transition is resulting in a slowdown in credit extension to the private sector, with borrowers becoming increasingly cautious due to the elevated cost of borrowing. Consequently, the overall economic growth is expected to decelerate to a range of 3.8 to 4.5 percent over the next year, reflecting the repercussions of constrained private sector credit. The current economic landscape in Uganda is characterized by a delicate balance between tackling inflation and sustaining economic growth. While the Central Bank's proactive measures bode well for long-term stability, the short-term implications entail challenges for borrowers and lenders alike. As the nation navigates through these turbulent times, a cautious approach to monetary policy and a keen eye on inflation dynamics will be crucial in charting a path towards economic resilience and sustainability.