The Bank of Uganda launched an inaugural benchmark lending rate and inflation target on Wednesday in a bid to tame the price pressures that pushed the east African nation's inflation rate to a 17-year high in May.
Bank of Uganda Governor Emmanuel Tumusiime-Mutebile said the bank would target 5-per-cent core inflation in the "medium term," without giving a specific time frame, and was setting a new central bank rate (CBR) at 13 per cent for July.
Uganda's core year-on-year inflation rate – which excludes food crops, fuel, electricity and metered water – stood at 12.2 per cent in June, up from 11.3 per cent a month earlier while the headline rate was 15.8 per cent, down from 16 per cent in May.
Analysts said it might take the Ugandan shilling time to respond, but that the central bank's tight monetary policy stance meant the currency should continue its climb from all-time lows against the dollar hit in June.
The Ugandan shilling slipped on Wednesday as corporate demand for dollars picked up, although the central bank's announcement of a new inflation target and benchmark rate may lend some support, traders said.
"Ideally, the shilling should strengthen a bit. This is a key indicator for it to go up, but we would wait and see reactions from offshore people in the market," said Robert Aloo, a trader at Kenya Commercial Bank.
"If they see that rates will continue going up then we might see a positive impact on the shilling. But people will keep looking at real return and if inflation will erode their investments," he said.
Analysts said it was still very early to predict where the market will move.
"Over the long term it would be good for the market. Shilling are short in the market right now after the central bank came in with several repos. This can be a good move eventually once the market stabilizes and there are good inflows," said Kamal Shahzad, a trader at Crane Bank.
"At the moment the dollar rate is quite high, but once it stabilizes to about 2,400 level then we can see some real effects and the inflation rate coming down," he said. (On Wednesday, $1 U.S. was trading for 2,575 shillings.)
Shop owners in parts of Uganda shuttered their businesses on Wednesday to protest against a weakened currency and runaway inflation, the latest in a series of economic protests in the east African country this year.
Uganda's new Central Bank Rate will be set at the start of every month at a meeting of the bank's 11-member Monetary Policy Committee. It will be announced at a news conference in the first week of every month.
"The Bank of Uganda intends to maintain a tight monetary policy stance, to curb demand for credit and thus dampen inflationary pressures over the next six to 12 months, so as to ensure that core inflation is pulled back toward the target of 5 per cent," the Governor said.
"Although the supply-side shocks to inflation are likely to dissipate over the medium term, the Bank of Uganda is determined to prevent higher rates of inflation from becoming persistent and allowing expectations of higher inflation to take hold."
The central bank said it would steer seven-day interbank rates as close as possible to its new Central Bank Rate through its daily market operations, with an upper limit of 15 per cent and a lower level of 11 per cent.
Some analysts said they had expected a higher central bank rate given one-week interest rates are running above 16 per cent, but given the central bank's stated determination to tackle inflation it should be positive in the long run.
"With the promise of more tightening still to come, market expectations will be firmly geared towards further policy rate increases, especially if the FX threat to the inflation target remains sustained," said Razia Khan, Africa economist at Standard Chartered Bank in London.
"For now, the policy rate is at least positive with respect to core inflation. From an economic perspective, the BoU is delivering what is needed. Real interest rates are positive with respect to core inflation, and given the substantial impetus to inflation as a result of supply-side shocks, yes, there is a requirement not to overdo the pace of tightening."
Bank of Uganda research director Adam Mugume said there was concern that the country's core inflation would remain "sticky" and persistently above the 5-per-cent target for most of 2011.
"Forecasts indicate the core annual inflation rate remaining between 10 and 12 per cent in the period July-September, 2011, while headline inflation is forecast at to be in range of 12 to 14 per cent in the same period," Mr. Mugume said.