Before Monday’s monetary policy meeting, annual consumer price inflation had risen sharply in the past two months, climbing to a 15-month high in May. But this did not stop the policy committee from reducing the central bank rate for the eighth consecutive time, even though the central bank’s policy target is to control the general rise in consumer prices.
This is because core inflation, the primary target of the bank’s policy, rose modestly above the target rate of 5% to 5.1%. In its monetary policy statement released after the meeting, the committee pointed out that core inflationary pressures had weakened somewhat over the past 12 months due to the relative stability of the exchange rate and subdued domestic demand. The bank also expects inflation to stabilise around the target in 12 months.
Instead, its decision to cut the central bank rate by one percentage point to 10% was influenced by the slowdown in economic growth. “With domestic inflationary pressures remaining subdued and given the continued weak growth prospects, the BoU judges that continued easing of monetary policy is appropriate,” the monetary policy statement said. “This will be consistent with achieving the core inflation target of 5% over the medium-term and will also support the recovery of real output in the economy.”
The economy is expected to grow by 3.9% in 2016/17 – the slowest rate in four years, and slower than earlier projections of 5%. As BoU notes in the statement, the slowdown is “mainly due to the drought that affected agricultural production, coupled with slow implementation of public investment projects and weak private sector credit growth.”
The central bank rate influences interest rates by steering short-term interbank rates, which has an effect on the rates at which banks lend to the private sector. By reducing the CBR, BoU is signalling to the commercial banks to reduce their lending rates and make credit more attractive to the private sector.
Indeed, figures from the central bank show that lending rates have come down in response to its expansionary policy. Average lending rates fell to 20.5% in April from their peak of 25.2% in February 2016.
Banks are still reluctant to issue more loans despite lowering their lending rates, even then, mostly because of their larger-than-usual stock of nonperforming loans. Private sector growth in the quarter to April expanded at a year-on-year rate of 3.4% versus 4.0% in the quarter to January 2017. The central bank blames supply-side constraints; while the demand for credit is high, loan approvals remain subdued.
But Bank of Uganda believes there is room for more growth in private sector lending. It is also issued a higher forecast, 5%, for GDP growth in the financial year starting July, which it said will be supported by “improved efficiency and effectiveness in implementation of public investments; higher foreign direct investments, particularly in the oil sector; and recovery in private sector credit growth.”