UPDATE 2-Uganda trims key rate again citing sluggish growth

(Adds analysts' comments)

* CBank has lopped 11 pct points off rate this year

* Says it wants to give a jolt to sluggish growth

* Traders say cut risks sapping confidence in shilling

* Aid freezes could cut growth by 0.7 pct -Governor

(Adds analysts, background)

KAMPALA, Dec 4 (Reuters) - Uganda's central bank trimmed its

key lending rate for December On Tuesday, a move

that surprised some traders who said the cut might reignite

pressure on the local currency.

Currency and fixed income traders in the Ugandan capital had

broadly expected the central Bank of Uganda (BoU) to leave its

key rate unchanged after inflation rose in November

for the first time in eight months.

Instead, the central bank cut the rate by 50 basis points to

12 percent citing sluggish economic growth. The bank has now

lopped off a total of 11 percentage points this year after

jacking up interest rates in the second half of 2011 to rein in

runaway inflation and support an ailing currency.

In a briefing note, Citi described the policy statement as

"more dovish" than the last and which "leaves room for further

policy easing."

The Ugandan shilling shed 0.4 percent after the rate

decision, with commercial banks quoting the shilling at

2,685/2,695 per dollar at 1300 GMT from 2,675/2,685 just before

the cut.

"There are emerging fears the surprise rate decision will

depress interest rates on debt and spur capital flight," said

Rodgers Lutaaya, chief dealer at Bank of Africa.

"And if those fears materializes then certainly the shilling

will take a hit and could slide past 2,700 again."

Faisal Bukenya, head of market making at Barclays Bank

Uganda, said the cut, although small, risked sapping confidence

in the shilling which is down 7.8 percent against the U.S.

currency this year.

"We'll possibly see BoU increase the size of its debt

auctions as it tries to tighten liquidity and limit harm for the

shilling," Bukenya said.

But with yields expected to fall in line with the rate cut

invertors would be less likely to buy into Uganda's debt market

while existing foreign holders of Ugandan paper would be less

likely to roll over maturing debt, instead exiting the market

and exchanging shillings for dollars, Bukenya said.

AID CUTS THREATEN GROWTH

The central bank has been easing its monetary policy stance

since early this year, saying it was keen to spur a recovery in

consumer spending and a return of the country to its growth

potential.

However, the bank's Governor Emmanuel Tumusiime-Mutebile

warned the economy would suffer further if donors, who fund up

to a quarter of the annual national budget, withhold aid over a

corruption scandal.

The European Union (EU) became the latest donor to suspend

aid to Uganda alleging the embezzlement of $13 million in aid

funds by officials in the Prime Minister's office.

"If all donors being reported to have cut their aid do cut

their aid, we think that this will reduce the potential growth

rate by about 0.7 percent," he said.

The central bank says Uganda's projected growth rate of

about 4.3 percent for the 2012/13 (July-June) fiscal year is

below the country's potential growth rate of around 7 percent -

what it calls a negative output gap.

"...the negative output gap is expected to persist through

2012/13," Tumusiime-Mutebile told a news conference.

"Inflation pressures are currently subdued and are likely to

remain so in the near term because of the negative output gap,"

he said.

The governor said the latest rate cut would not jeopardise

the bank's medium term inflation target of 5 percent. Ugandan

headline inflation rose to 4.9 percent year-on-year

in November from 4.5 percent a month earlier.

Yields on Uganda's debt instruments had been edging up in

the past few weeks after declining for much of the year in line

with the bank's monetary policy easing cycle.

Rates on both the 182- and 364-day Treasury bills have risen

by 3 percentage points since mid October while the benchmark

91-day paper has steadied at around 9.8 percent.

(Editing by Richard Lough; editing by Ron Askew)

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