The Bank of Uganda has reduced interest rates for the first time since February 2018 in a bid to support economic growth.
The monetary policy committee agreed to reduce the central bank rate (CBR) by 1% to 9%, while the rediscount rate and the bank rate were also adjusted by a similar amount to 13% and 14%, respectively.
The central bank rate is intended to guide short-term interbank (bank-to-bank) lending rates and thus determine the cost of new funds for commercial banks. When the CBR is reduced, the expectation is that interest rates on the interbank lending market will fall, influenced by the central bank’s purchase and sale of securities to banks in its open market operations.
It’s also intended to ease market interest rates at various maturities according to expected future short-term interest rates, and lowering in lending rates of commercial banks in agreement with the term structure of interest rates.
The rate cut comes days after the Uganda Bureau of Statistics announced that annual core inflation, the central bank’s preferred measure of inflation, had fallen for the third straight month to a 14-month low in September to 2.5%. The headline inflation rate also fell to a 16-month low, dropping to 1.9% from 2.1% the previous month.
The central bank’s monetary policy committee said that it expects inflation to remain subdued in the near-term and revised its inflation outlook downwards compared to the August forecast. According to the revised outlook, annual core inflation will remain below the 5% policy target until the fourth quarter of 2020.
It’s this “benign inflation outlook” that gave policymakers room to reduce the central bank rate to support economic growth. “The economy still has spare capacity and lower interest rates will help reduce the output gap,” said the monetary policy statement.
Economic activity slowed down in the first half of this year compared to the second half of 2018, the statement said. Real gross domestic product growth in the three months to the end of June was 5.4%, unchanged from the first quarter of the year; real economic expansion in the third and fourth quarters of 2018, on the other hand, was 6.6% and 6.8%, respectively. The Bank of Uganda’s high frequency indicator of economic activity indicates a moderation in economic activity in the first quarter of 2019/2020 (July to September).
BoU said its outlook on economic growth is uncertain, mainly because of the unfavourable global economy. “…A combination of widening fiscal and current account deficits, coupled with public sector domestic financing needs, could exert pressure on the lending interest rates leading to further moderation of economic growth,” it added.
The central bank rate is set bi-monthly by the central bank’s monetary policy committee in line with a 12 month outlook for core inflation, an estimate of the output gap (the difference between the economy’s actual and the potential or equilibrium output) and qualitative judgments.