Experts at the Makerere-based Economic Policy Research Centre (EPRC) have said inflation could hit double digits as early as next month.
This has raised fears that a country could slide back to the 2011 era, when inflation topped 30 per cent. Headline inflation, which measures the general increase in prices of goods and services, rose from 5.1 per cent in July to 7.3 per cent last month.
While core inflation, a measure of increase in prices of goods and services minus food and utilities, jumped from 5.8 per cent in July to 6.6 per cent - far above Bank of Uganda (BoU)'s target of five per cent.
On its blog, EPRC, a leading local economy think tank, wrote: "... inflation may hit double digits by October 2013 as the full effects of the drought and resultant shocks to agriculture are realised."
Indeed, BoU says food prices, which rose by 16 per cent in August 2013, could continue increasing - driving up inflationary pressures. Presenting monetary policy statement for September last week, Governor Emmanuel Tumusiime-Mutebile said: "Uganda is currently facing a supply side shock to agriculture which has raised food prices and may impede real growth in 2013/14.
The risks to the outlook for the core inflation over the next 12 months, which is the target for monetary policy, have already increased."
BoU had earlier predicted that the economy would grow by between six per cent and seven this financial year, but if inflation upsurges further, it may be forced to rethink its forecast. Drought has hit the country in the past months, shrinking farmers' harvests and sending waves of shock through the economy.
And BoU could not wait to switch gears from facilitating economic growth - which necessitates low interest rates - to taming inflation by raising the Central Bank Rate (CBR) to 12 per cent. In show of confidence, BoU had maintained the CBR at 11 per cent for the past three consecutive months and the change in thinking reflects some darks clouds in the skies ahead.
The CBR is the rate at which the BoU lends to the commercial banks. When it is high, banks increase prime lending rates and when it's low, they go down. But EPRC thinks rising CBR is not good enough a solution.
"When the primary cause of inflation is a shock to the agricultural sector, tightening of monetary policy alone may not provide the desired results," EPRC said. "In such circumstances, the fiscal side (budgetary expenditure) must respond by providing the appropriate budgetary allocations to boost production and productivity."
However, BoU says it does not expect a repeat of the inflationary surge which occurred in 2011.
Meanwhile, Mutebile warned commercial banks against raising interest rates. Average prime interest rates are 23 per cent, and whether banks will heed his warning is another matter. Even when the CBR fell to 11 per cent, banks remained cynical and refused to cut interest rates, despite continuous appeals from BoU.