Bank interest rates may have to raise to fight inflation, says experts

Mar 12, 2022

The upward trend in inflation has been linked largely to global geopolitics in Russia and Ukraine that has disrupted supply chains, impacting prices of some food crops, energy, and fuel prices.

The deputy governor BOU, Michael Atingi-Ego. File photo

Ali Twaha
Journalist @New Vision

The Bank of Uganda (BOU) may gradually embark on monetary policy tightening (or increasing interest rates) to tame swelling inflation pressures building up in the economy, experts have said.
 
Monetary policy is set by the central bank with a future projection of inflation and the path of economic growth in mind. 
 
Uganda’s inflation is now running at 3.2%, the highest recorded by the Uganda Bureau of Statistics since June 2020. 

The upward trend in inflation has been linked largely to global geopolitics in Russia and Ukraine that has disrupted supply chains, impacting prices of some food crops, energy, and fuel prices.
 
Despite these events, the BOU says inflation remains under its target of 5% but “there could be inflation surprises” in the months to come because of a stronger rise in food crop, commodity import prices, and the exchange rate depreciation. 

“We expect the BOU to commence its policy tightening cycle as inflationary pressures rise and evidence point to a stronger economic backdrop," Jeff Gable, Chief Economist Absa Group, says.
 
“Our expectation is that interest rates are likely to raise. When that will happen and by how much is a real question mark because of the huge uncertainty created by the global environment in Russia and Ukraine.” 

Gable was speaking during the launch of the Absa Africa Financial Markets Index 2021 and the Economic Outlook in Kampala. 

The event was attended was the deputy governor BOU, Michael Atingi-Ego, Permanent Secretary to treasury Ramathan Ggoobi among other officials from key government agencies. 

The Ukraine-Russia conflict has seen soaring energy prices over the last two weeks, which has triggered inflation pressures globally.

“The rise in the prices is a temporary shock,” Ggoobi noted in a move to cool mounting fears of rising commodity prices. 

Higher inflation affects everyone - from higher prices at the pump station to making harder choices when doing your next shopping list. 

The central bank has kept the lending rate to financial institutions at a record low of 6.5% since June 2021.

Projected future tightening of monetary policy will be a move away from a very accommodative stance held by the regulator over the last two years intended to stimulate economic activity due to the pandemic. 

In its February Monetary Policy briefing, Atingi-Ego noted that there are considerable uncertainties surrounding the inflation outlook for the country with the most significant being the disruption in global production supply chains. 

“If the upswing in global cost-push inflation pressures turns out to be larger or more persistent than currently expected, it could spill over into the domestic economy, especially so, if combined with a weaker shilling. 

“If the exchange rate were to depreciate significantly, partly on account of higher demand for foreign currency and monetary policy tightening in advanced countries, this would increase the overall inflation pressures and foster a need for tightening monetary policy going forward,” he said.

Higher costs on commodities such as fuel in the local market are being influenced by global factors largely outside the BOU control. 

The increase in interest rates to banks also known as the central bank rate is one of the many ways BOU tries to control prices. 

If interest rates rise, it can make borrowing more expensive but it can also give savers a better return on their savings—which could encourage them to save rather than spend.

Encouraging people to save should slow the increase in prices of everyday goods. With fewer buyers in the market, sellers will find it hard to put their prices up.

“BOU raising lending rate may be a positive but it may not feel that way if you have a loan. But it’s a positive one in the sense that it reflects an economy that has continued its recovery from the worst of the pandemic and getting closer to business as usual. That’s the message and we are seeing that happen globally,” Gable said. 

However, at the next monetary policy briefing expected in April, the BOU monetary policy committee may have to tighten too quickly and slow economic growth projections or tighten too slowly and risk losing medium-term inflation expectations. 

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