Shilling gains ground as Central bank intervenes

For the second time in a row, Bank of Uganda has increased its key monetary rate, this time by 25 basis points, as it tries to slow down a spike in the prices of goods and services, and arrest further depreciation of the shilling.

Bank of Uganda increased its central bank rate to 10.25 per cent for April 2024, targeting the depreciation of the shilling against the dollar. The shilling has been hit hard over the last one month, nearly breaching the Shs 4,000 psychological barrier as foreign investors fled Uganda for more lucrative capital markets where the return on investments were better.

While reading the monetary policy statement for April, Michael Atingi-Ego, the deputy governor of Bank of Uganda, said “the shilling remains vulnerable due to outflows of short-term foreign investor funds from the domestic market and strong domestic demand by corporates.” He further explained that “the weakening of the shilling significantly impacts domestic prices, which could push inflation higher.”

Atingi-Ego pointed out that “the evolution of inflation remains challenging, influenced by factors such as the shilling exchange rate, supply-side shocks, global inflation, and domestic food supply.”

He explained that the central bank’s move to raise its key monetary rate in March led to an appreciation of the shilling. It appears, though, that the appreciation was not high enough to maintain the key rate. A further tightening of the monetary policy was needed, if the central bank move is to be interpreted correctly.

Also, the central bank noted that the appreciation of the shilling reflected a slight drop in the percentage change in the prices of goods and services, otherwise known as inflation. According to the central bank’s numbers, headline inflation – which measures the overall change of goods and services – dropped to 3.3 per cent in March from 3.4 per cent in February.

The bank, however, attributed the drop mainly to a decline in food prices, which carry a heavier weight when calculating the number. The inflation print is part of the reason as to why the central bank decided to tighten its monetary policy further, which also aims to mop out any excess money within the economy.

“We are taking further action because we still see the vulnerabilities to the inflation outlook,” Atingi-Ego said.  

The central bank forecasts that Uganda is not yet out of the woods when it comes to inflation. Bank of Uganda predicts that inflation may rise to between 5.5 per cent and 6 per cent over the next 12 months, and thereafter drop within its target range of 5 per cent.

Inflation is one of the most watched numbers in an economy. When inflation goes up, it weakens the spending power of consumers, eating into their disposable incomes in order for them to be able to afford the spike in the prices of goods and services.

High inflation also makes credit expensive, meaning that businesses have to borrow expensively in order to thrive. Those who cannot borrow expensively have to cut back on their expenditures, and in certain drastic measures lay off workers.