Uganda's central bank unexpectedly trimmed its benchmark lending rate by 50 basis points to 11.5 percent on Tuesday, saying economic growth remained below potential.
The east African nation of 33 million people has endured a period of sluggish growth since 2011, when inflation soared.
A period of high inflation and high interest rates was then followed by cuts in budget aid from key donors due to a row over claims of corruption in the prime minister's office.
Deputy central bank governor Louis Kasekende said there were signs of recovery, helped by the central bank's monetary stance and public spending on infrastructure projects.
"Nonetheless, economic growth remains below potential and downside risks pertaining to the uncertain global economic environment exist," Kasekende told a news conference.
"Given the current projections of annual core inflation and the need to further support private sector investment, an accommodative monetary policy stance is warranted."
Year-on-year core inflation, which excludes both food and fuel costs, edged down to 7.0 percent from 7.2 percent last month and the central bank expects it to stabilise around its target of 5 percent in the medium term, Kasekende said.
Market participants said the rate cut caught them by surprise but added that the move was not likely to have much impact on the foreign exchange rate.
"Given the well-established anti-inflation credentials of the Bank of Uganda, this is unlikely to have much impact on the Ugandan shilling," said Razia Khan, head of research for Africa at Standard Chartered in London.
The shilling was stable at about 2,526 per dollar after the rate cut.
Khan added that the outlook for annual headline inflation, which dropped to 6.8 percent last month from 8.1 percent previously, was likely to temper the urge for further easing.
Kasekende said the rate is likely to fall further to 5.5-6.5 percent in the next three months due to good harvests, before rising to 7 percent in the second half of next year. Reuters