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Uganda: Low Enough for Now

Cut like you know. Last week saw the central bank of Uganda trim the policy rate by 100bps to 10 percent. This was the latest of a sequence of cuts since last March when the benchmark stood at 17%. Taken at face value, the ongoing pace of declines looks somewhat at odds with the steady pickup in headline inflation from 4.1% in October to 7.2% in May. However, it is worth bearing in mind that the Bank of Uganda is aiming for a medium-term target of 5% for the core rate of inflation, which strips out the impacts of volatile energy and food price movements. While, the headline rate has been climbing, largely reflecting the fallout from the recent regional drought, core inflation has hovered around its target and the BOU has, accordingly, been emboldened to try and support growth by easing monetary policy.

Testing the floor? It might seem reasonable, on current trends, to conclude that the current bout of easing still has considerable momentum and that the policy rate could fall to say 7-8% by this time next year, However, in our view Governor Tumuslime-Mutebile should tread more cautiously from here on. With annual GDP growth softening to 1.4% y/y in 2016 Q4, it is understandable for the BOU to want to help support a turnaround in activity. But given the Bank's own projections of a pickup to 5% in FY 2017/18 on the back of rebounding food production, government spending and FDI, it would seem prudent to pause for a few months and assess if further support is required. There is a real risk that further significant loosening while headline inflation continues to rise could lead to undesirable second-round effects on inflation expectations and labour costs while casting doubt on policy credibility.

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