Uganda raises key lending rate to curb inflation expectations

By Elias Biryabarema KAMPALA (Reuters) - Uganda's central bank unexpectedly raised its benchmark lending rate on Tuesday, a move which analysts say could make local debt yields attractive and help the shilling to firm. Price pressures in Africa's biggest coffee exporter jumped to an 18-year high in October 2011 when headline inflation hit 30.5 percent. Since then the central bank introduced a benchmark rate and applied aggressive monetary policy moves to tame prices. But a drought has recently driven food prices higher and with it inflation, which rose to 7.3 percent in the year to August, from 5.1 percent in July. The Bank of Uganda hiked its key interest rate by 100 basis points to 12 percent, citing above-target core inflation. "Although annual core inflation will probably remain above 6 percent for the next few months, by tightening monetary policy now, I am confident that it will fall back towards our policy target of 5 percent by the third quarter of 2014," Bank of Uganda Governor Emmanuel Tumusiime-Mutebile said. The bank did not expect the inflation rate to shoot to levels which occurred in 2011 as factors like rapid credit growth did not pose the same threats at present, the governor told a news conference. The central bank's move was intended to keep in check any second round effects on non-food prices resulting from a food supply shock, Tumusiime-Mutebile said. "I am fully aware of the potential impact of this on real sector activity. However, it is my strong view that this is a necessary action to anchor inflation expectations and to support economic growth over the medium to long term," he said. By 1213 GMT the shilling had strengthened to 2,572/2,582 per dollar, up from 2,783/2,793 before the rate rise and from Monday's close of 2,588/2,598. Foreign exchange traders said they expected the shilling to strengthen further going forward once yields on local government securities start rising in reaction to the central bank rate rise, and attracting foreign investors. "Going forward if yields back the policy tightening stance, there should be rise in inflows from offshore debt investors and potential more gains for the local unit," said Ahmed Kalule, trader at Bank of Africa Uganda. Tumusiime-Mutebile said that banks should not use the rate hike as a reason to widen interest rate spreads. Uganda had held its benchmark rate at 11 percent for the previous two months, having cut from 12 percent in June, the first time it had cut its rate in six months. "The move is a surprise, not least because of the large spread between CPI and the CBR," said Razia Khan, regional head of research for Africa at Standard Chartered Bank. "Nonetheless, with August inflation rising faster than expected, the Bank of Uganda is taking seriously the risk of further pressure on prices." Khan said that while inflation was expected to rise further in coming months, a strong shilling gave the bank leeway in how fast to tighten its monetary policy. "The anti-inflation credentials of the BoU will receive a boost from this decision, which should itself be an influence on where inflation peaks," she said.