By Duncan Miriri NAIROBI (Reuters) - Kenya's core inflation rate plunged in July to its lowest rate for 5 1/2 years, justifying the central bank's decision to cut rates this month and inject liquidity into the economy, analysts said on Friday. The consumer price index in east Africa's biggest economy fell 1.4 percent in July from June, the third successive monthly decline, leaving the headline year-on-year inflation unchanged at 17.8 percent thanks to high food prices. But the underlying inflation rate, which excludes food items, slumped to 4.5 percent from 5.8 percent in June, the first time it has fallen below the central bank's 5 percent target since May, 2006. It was last lower in January, 2004. The Central Bank of Kenya (CBK) cut its key lending rate in July for the fourth time since December and lowered the cash reserve ratio (CRR) for banks, saying there was no inflationary threat from expanding credit to boost economic growth. "The apparent stickiness of the headline rate of inflation matters less than the fact that core inflation has finally fallen back within the target," said Razia Khan, Standard Chartered's head of Africa research. "Given recent measures by the CBK to boost liquidity, including the cut in the CRR, some would have worried about potential inflationary consequences. This print proves that such fears were not founded," she said. SLUGGISH DEMAND Kenya's economy growth slumped to 1.7 percent last year from 7.1 percent in 2007 after post-election violence, poor weather and the global economic slowdown stunted activity. The central bank said this week the economy was on track to hit the government's forecast of 3 percent growth this year, but that it was setting monetary policy to try and achieve higher expansion rates. "The plunge in the core rate is encouraging and validates the central bank's policy of easing aggressively. The downside for sentiment is that it confirms a broad picture of sluggish domestic demand," said Richard Segal, economist at UBA Capital. The central bank said when it cut rates this month that there was significant slack in the economy and no inflationary threat from boosting credit to try and stimulate growth. In neighbouring Uganda, inflation rates have also been running in double digits due to high food and energy prices over the past year and a depreciating currency. In July, the headline annual average inflation rate slowed to 11.6 percent from 12.3 percent in June while the core rate, which excludes food, energy and metered water prices, fell to 10.4 percent from 11 percent the previous month. | 
