Uganda’s Central Bank hikes benchmark rate to 10.25%

The Central Bank of Uganda recently announced a 25 basis point increase in its benchmark interest rate, raising it to 10.25%. This move was made in response to concerns about rising inflation levels and the bank's commitment to maintaining inflation within the target range of 5%. Phillip Ssali, Head of Corporate Sales & Global Markets at Standard Bank Group, provided valuable insights into the reasons behind this decision and its potential impact on the economy. The decision to raise the interest rate was primarily driven by the potential risks associated with inflation. High-frequency monetary policy indicators suggest that inflation in Uganda could rise from 3.5% to 5.5% over the next 6-12 months before reverting to the 5% target. Geopolitical tensions and supply shocks, such as increases in oil prices, were identified as key drivers of inflation. Additionally, currency fluctuations, particularly the depreciation of the shilling, have historically contributed to inflationary pressures. While recent measures have helped stabilize the shilling, the Central Bank deemed it necessary to raise interest rates to mitigate future risks. The increase in the central bank rate has also had a positive impact on stabilizing the shilling exchange rate. Despite initial depreciation, the shilling has shown signs of strengthening, which bodes well for controlling import costs and inflation. Looking ahead, factors such as coffee exports and foreign direct investment are expected to support the shilling, although potential risks from capital outflows remain. In terms of inflation management, recent data showed a decline to 3.3% in March, driven partly by a reduction in food inflation. However, uncertainties surrounding weather conditions and geopolitical factors pose ongoing risks to inflation levels. Shifting focus to Kenya, the banking sector has been grappling with a record high level of non-performing loans (NPLs) at 15.5%. This surge can be attributed to a regulatory change in accounting standards in 2018, which required banks to anticipate and provision for potential loan defaults. While this shift has impacted the banking sector's financials, it is not indicative of a weak economy but rather a change in reporting standards. Moving forward, banks are likely to adopt stricter lending criteria and impose higher risk premiums on certain sectors with elevated credit risks. Despite the challenges posed by NPLs, the overall economy's resilience will depend on factors like government spending, foreign direct investment, and private capital inflows. It is reassuring that major Kenyan banks have built substantial capital buffers to mitigate potential risks and ensure a healthy banking system, which is crucial for long-term economic stability.