A report prepared by the Bank of Uganda (BoU, the central bank) has shed some light on a potential change in monetary policy, as the dangers of inflation appear to pose more of a challenge than the risks of slower economic growth. In a special report of monthly economic and monetary developments, prepared for a meeting with local bankers in December, the BoU outlined the need to support the economic recovery without compromising its inflation objectives. Inflation has started to rise again and the bank made it clear that the key factor driving monetary policy would be the short-term inflation forecasts. The report shows evidence of a strengthening economy that would allow a degree of monetary tightening. The bank is therefore likely to mop up excess liquidity in the market in its efforts to limit the rise of inflation, and monetary policy looks as though it will be tighter in 2011 than it was in 2010.

The BoU will also continue with a policy of intervention in the currency market to limit the depreciation of the shilling, although it continues to insist that there is no fixed rate target. The BoU spent US$60m in November supporting the currency, which depreciated by 15% during 2010. The shilling fell further, to an all-time low of USh2,400:US$1, in mid-January as political uncertainty in the lead-up to the elections, low export earnings and strong demand for US dollars in the energy sector affected confidence in the currency (February 2011, Economic performance). The BoU report highlighted the limited ability of the central bank to influence the value of the currency. The Economist Intelligence Unit expects that volatility of the currency will dissipate in the wake of the peaceful elections. Reduced political uncertainty will also lead to increased foreign-exchange inflows from donors and investors, which will support the currency. Moreover, if monetary policy is tightened in 2011 as we expect, the higher interest rates will attract capital inflows, further bolstering the currency.