several months thereafter. this was a pure supply side shock to prices and had nothing to do with excess demand or to too much money chasing too few goods. the impact of food prices on inflation was exacerbated in the middle of 2011 by the weakening of the exchange rate. this was mainly due the deteriorating bop position that i have just described, but the volatility in the exchange rate also reflected some speculation against the shilling on the part of ugandans who purchased dollars to hoard and foreign portfolio capital investors. the turbulence on the global financial markets, which entailed stock prices and exchange rates gyrating on a daily basis, also affected volatility in the ugandan exchange rate and the exchange rates of other developing countries, including kenya. between the end of may 2011 and the end of september 2011, the nominal bis central bankers ’ speeches exchange rate of the ugandan shilling depreciated by 19 percent against the us dollar, as shown in figure 3. the exchange rate depreciation drove up the domestic prices of imports ; for example fuel, clothing and various household goods. moreover, the combination of higher food prices and higher import prices began to spill over into other prices, such as the prices of services which comprise nearly half of the consumer basket. for example, school fees were raised because the cost of food had risen. by the first quarter of 2011 / 12, inflation was becoming more generalised in that it was affecting most items in the consumer basket. the very rapid growth in bank lending to the private sector, which by september 2011 had reached 44 percent on an annual basis, was also contributing to the build up in inflationary pressures. monetary policy the rise in inflation created difficult challenges for monetary policy. monetary policy affects the demand side of the economy ; it influences spending by the private sector, which comprises about 80 percent of total final expenditure in the economy. monetary policy does not affect the supply side of the economy ; therefore it is ineffective as a tool for reversing pure supply side shocks to prices. consequently monetary policy could not realistically be expected to have prevented the rise in food prices which occurred last year. however supply side shocks such as those which affected food prices and the exchange rate in 2011 will have serious long term consequences for inflation, long after the shocks themselves have dissipated, if they are allowed to spill over into a much broader range of prices, such that inflationary expectations become entrenched in the mind of the public. this is

a serious risk of the unanchoring of these expectations. our decision demonstrated our determination to continue solidly anchoring inflation expectations including in the turbulent circumstances that we had to cope with. this demonstration of alertness proved extremely useful in the period that followed, after midseptember, when we had to guard against both deflationary risks in the short term and inflationary risks in the medium and longer term. after the acute intensification of the crisis ( and following the reduction of the ecb ’ s policy rates in october 2008 ), nominal yields at two and three - year maturities fell in the euro area, as shown in figure 1. this partly reflected private expectations that the cut in policy rates would prove persistent. at the same time, as revealed by the developments in break - even rates illustrated in figure 2, private expectations regarding euro area inflation remained correctly anchored, even at these relatively short horizons. by implication, real rates at such maturities fell substantially, as shown in figure 3. to the extent that real rates are the relevant determinant of private spending – as canonical models of transmission would suggest – the evidence points to significant monetary easing in the euro area. this very significant monetary easing was made possible by changes to the policy rate that were of a magnitude permitting us not to run into lower - bound constraints. 27 of course, extracting relevant information from financial market prices – as is implicit in these charts – is particularly difficult at times of market turmoil, when liquidity premia and safehaven effects may be larger than normal. such caveats imply a need for caution when interpreting these developments. 28 nonetheless, the evidence supports the view that a central bank ’ s ability to ease monetary conditions – and thereby support the stabilisation of inflation and output – is significantly enhanced by its ability to anchor private expectations. the effectiveness of the ecb ’ s interest rate decisions is reflected in the continued credibility of the ecb ’ s monetary policy. notwithstanding the substantial economic and financial shocks experienced recently in the euro area, longer - term private inflation expectations have remained securely anchored at levels consistent with price stability. by way of illustration, the average private inflation forecast at the six to ten - year horizon ( as collated by consensus economics ) was 1. 9 % in june 2009. ten - year break - even inflation rates derived from indexed bonds also hovered at levels just below 2 % ( see figure 4 ). even at the peak of the crisis, there was no disc