Uganda's central bank has trimmed its key lending rate, a move that surprised some traders who said the cut might reignite pressure on the local currency.
Currency and fixed-income traders in the Ugandan capital had broadly expected the central Bank of Uganda (BoU) to leave its key rate unchanged after inflation rose in November for the first time in eight months.
Instead, the central bank cut the rate by 0.50 percentage points to 12 per cent, citing sluggish economic growth. The bank has now lopped off a total of 11 percentage points this year after jacking up interest rates in the second half of 2011 to rein in runaway inflation and support an ailing currency.
In a briefing note, Citigroup described the policy statement as "more dovish" than the last and which "leaves room for further policy easing."
The Ugandan shilling shed 0.4 per cent after the rate decision.
"There are emerging fears the surprise rate decision will depress interest rates on debt and spur capital flight," said Rodgers Lutaaya, chief dealer at Bank of Africa.
Faisal Bukenya, head of market making at Barclays Bank Uganda, said the cut, although small, risked sapping confidence in the shilling, which is down 7.8 per cent against the U.S. currency this year.
"We'll possibly see BoU increase the size of its debt auctions as it tries to tighten liquidity and limit harm for the shilling," Mr. Bukenya said.
But with yields expected to fall in line with the rate cut, investors would be less likely to buy into Uganda's debt market while existing foreign holders of Ugandan paper would be less likely to roll over maturing debt, instead exiting the market and exchanging shillings for U.S. dollars, Mr. Bukenya said.
The central bank has been easing its monetary policy stance since early this year, saying it was keen to spur a recovery in consumer spending and a return of the country to its growth potential.
The central bank says Uganda's projected growth rate of about 4.3 per cent for the 2012-13 (July-June) fiscal year is below the country's potential growth rate of around 7 per cent – what it calls a negative output gap.
Yields on Uganda's debt instruments had been edging up in the past few weeks after declining for much of the year in line with the bank's monetary policy easing cycle.