Bank of Uganda on Wednesday reduced the policy lending rate by 0.5% to 11% citing an improved inflation outlook and the need to support private sector credit and economic growth.
The bank’s Monetary Policy Committee judged that inflationary pressures will recede in the near-term mainly due to the stable shilling. The stable exchange rate will help contain higher prices caused by the fall in agricultural output, a result of the recent drought.
As a result, the committee believes that core inflation will remain around the central bank’s medium-term target of 5%.
In explaining its decision to cut the central bank rate, the bank pointed to recently released data showing that the economy expanded by just 0.8% in the second quarter of the current financial year, compared to a decline of 0.1% in the first quarter.
That “weak economic performance” prompted the committee to qualify its earlier forecast that the economy will grow by 4.5% in the current financial year. The rate is unlikely to be achieved, the bank’s Monetary Policy Statement said.
It is the second time the central bank is lowering its growth forecast for the current financial year. In February, it downgraded the projection from 5.0% to 4.5% saying the slowdown in economic growth was likely to persist throughout the year. Uganda’s GDP expanded 4.8% in 2015/16.
“The anticipated lower growth in FY 2016/17 is largely driven by supply side factors, notably the impact of adverse weather conditions on agricultural output,” said the statement.
“The agricultural sector contracted on average by about 2% quarter-on-quarter for four consecutive quarters to the second quarter of 2016/17.”
Adam Mugume, the director in charge of research at Bank of Uganda, said agricultural output will pick up soon following the recent rains and planting season. But this will happen late in the financial year to have an impact on growth.
It is the seventh consecutive rate cut since April last year. The primary target of the bank’s monetary policy is to control core inflation – a measure of inflation that strips out the volatile food and energy prices – and keep it around the medium-term target of 5%.
The central bank rate also influences interest rates, as it is aimed at steering short-term interbank rates – the rates at which banks lend money to each other. This has an effect on the rates at which banks lend to the private sector.
Commercial bank’s credit to the private sector in February grew 7.5% year-on-year, the highest rate in 10 months and the fifth consecutive monthly rise. Growth dropped in 2016 compared to 2015, and was negative in August and September.
On a month-on-month basis, however, commercial bank lending to the private sector fell slightly in February. In cutting the rate further, Bank of Uganda is looking at a further fall in lending rates which will make credit more attractive.
A recent survey by the central bank found that most banks expect to lower their lending rates in the quarter to June because they were anticipating a decline in the central bank rate and due to more competition in the banking sector.
The rediscount rate and bank rate were also each reduced by 0.5 percentage points to 15% and 16%, respectively. The band on the central bank rate was maintained at +/-3%, and the margin on the rediscount rate at 4% on the CBR.