Zambia's central bank raised its key interest rate for the first time since November 2019 to contain rising inflation and anchor inflation expectations, and said it was "ready to adjust the policy rate upwards further should inflationary pressures persist."

The Bank of Zambia (BOZ) raised its Monetary Policy Rate by 50 basis points to 8.50 percent, partly reversing last year's aggressive monetary easing cycle when the rate was cut twice (May and August) by a total of 350 points to a historic low of 8.0 percent in response to the COVID-19 pandemic.

But since last year's rate cuts, Zambia became Africa's first sovereign pandemic-era default in November, the exchange rate of the kwacha has continued to weaken despite BOZ's scaled-up interventions, and inflation has accelerated sharply in the last three months.

In January Zambia's inflation rate hit 21.5 percent, up from 19.2 percent in December, the highest since April 2016, and BOZ said it expected inflation to deviate away from the upper bound of its target range of 6.0-8.0 percent due to the lagged pass-though from the kwacha's deprecation and sustained high fiscal deficits.

"This risks to the inflation outlook are assessed to be tilted to the upside," the bank said, adding inflation was bound to rise even further if the rise in crude oil prices persists, fiscal deficits turn out to be higher than projected and the exchange rate depreciates further.

The kwacha fell sharply in March last year in response to the outbreak of the pandemic but only bounced back marginally from April until August when pressure on the currency returned.

Today the kwacha was trading at 21.65 to the U.S. dollar, down 2.3 percent this year and down 35 percent since the start of 2020.

"Rising excess demand continued to characterize the foreign exchange market due to higher import requirements for petroleum products and agricultural inputs under FISP (Farmer Input Support Programme)," BOZ said, adding it had sold US$339.8 million in the fourth quarter of last year, up from US$148.5 million in the third quarter.

Due to foreign exchange intervention and debt service, Zambia's gross international reserves declined by $117.7 million to $1.2 billion at the end of December from end-September, enough for 2.4 months of import cover.

The economy of Zambia, Africa's second largest copper miner, shrank less than expected in the second half of 2020 as COVID-19 restrictions were partly relaxed, and this year BOZ expects gross domestic product to recovery, helped by growth in mining, electricity, gas and water, along with information and communication services.

However, BOZ said aggregate demand still remains subdued and growth will be weak given uncertainty surrounding the resurgence of COVID-19 infections and the narrow fiscal space.

In the third quarter of 2020 Zambia's GDP shrank an annual 2.6 percent, up from a 2.1 percent fall in the second quarter.