On 6 March 2024, a special meeting of the Monetary Policy Committee increased the Central Bank Rate to 10 per cent.
The unfolding of some of the risks mentioned in the February 2024 Monetary Policy Statement, including the depreciation of the shilling exchange rate, has triggered the need to tighten monetary policy. Inflation outturns in February 2024 indicate that both headline and core inflation rose to 3.4 per cent from 2.8 per cent and 2.4 per cent in January 2024, respectively.
While the main contributors to the rise in inflation are services and energy, fuel, and utilities, this combined with the depreciation of the shilling could spill over into general price increases if not contained. The exchange rate depreciation since November 2023, with sharp depreciation in February 2024, was in part caused by the outflow of some offshore investor funds from the domestic market in search of more attractive yields in other markets, strong domestic demand partly as a hedging mechanism against further depreciation, and seasonal factors.
Further exchange rate depreciation could push inflation above the medium-term target of 5 per cent by the second half of 2024. Additionally, whereas there are downward inflationary pressures arising from the continuing vanishing effects of supply-side shocks, receding global inflation and improved domestic food supply, these are likely to be outweighed by the effects of a weaker shilling.
Going forward, the inflation trajectory will be shaped by the outlook for the shilling and the other goods inflation. Inflation forecasts have been revised upwards in the short term (12-month horizon) in light of the exchange rate depreciation. Inflation is projected to rise above the medium-term target of 5 per cent by the first quarter of the 2024/25 financial year and stay above 5 per cent throughout 2025, unless monetary policy is tightened.
Risks to the inflation outlook remain highly dependent on the global and domestic environment. Specifically, higher global commodity prices partly due to geopolitical tensions and an increase in shipping costs resulting from the Middle East conflict as well as tighter global financial market conditions could result in higher domestic inflation. The MPC assessed the risks and the uncertainties to the outlook as broadly on the upside.
Economic growth is projected to remain unchanged at 6 per cent in the 2023/24 financial year. However, economic growth in the outer years is projected in the range of 5.5 per cent to 6.5 per cent compared with a previous projection of 6.5 per cent to 7.0 per cent. The downward revision to growth in the outer years largely reflects the likely impact of tighter monetary policy, which is required to stabilise inflation over the medium term. In addition, the rise in inflation could depress household real incomes, reducing consumer spending while investment expenditure could be dampened by high raw material import costs. Moreover, tax revenue underperformance could increase domestic financing, crowding out private sector credit growth and dampening economic activity. Furthermore, a sluggish recovery in external demand could reduce Uganda’s exports.
However, strengthening activity in the oil sector and the Financial Action Task Force’s removal of Uganda from the grey list on 23 February could unlock additional FDI inflows and somewhat mitigate the above negative effects above. Overall, risks to growth are tilted to the downside.
The risks to the inflation outlook are elevated, necessitating a tighter monetary policy stance. Therefore, the MPC raised the CBR by 50 basis points to 10 per cent. The bands on the CBR remain at +/-2 percentage points and the margins on the CBR for rediscount and bank rates at 3 and 4 percentage points, respectively. As a result, the rediscount and bank rates will rise to 13 per cent and 14 per cent, respectively. Going forward, there are prospects for a higher CBR to bring inflation down and anchor inflation expectations or a lower CBR if the risks do not materialise.
Faster sustainable growth can only occur in an environment where inflation is low and stable. High inflation rates hurt economic growth, leading to significant and permanent reductions in per capita income. Therefore, tightening monetary policy in the current circumstances is consistent with supporting sustainable growth, which is a prerequisite for socio-economic transformation.
Michael Atingi-Ego
Deputy Governor
