(Adds details from central bank statement, background)
By Elias Biryabarema
KAMPALA, March 12 (Reuters) - Uganda's central bank said on Thursday it would use interest rates to keep inflation from rising above a medium-term target of 5 percent, reassuring investors worried by a planned hike in state spending and shilling weakness.
The shilling has plunged to record lows against the dollar on concerns that the government would increase spending before the 2016 election will lead to the same spike in inflation that hammered the economy after the 2011 vote, sparking street protests and a police crackdown.
The local currency closed at 2940/2950 on Thursday, recovering from a new record low of 3,116/3,126 earlier, after the central bank sold an unspecified amount of dollars.
The bank has sold dollars at least eight times this year to support the weakening shilling.
Traders said some of Thursday's weakness came after foreign investors sold off government debt, worried by the state's plans for increased spending in the current 2014/15 fiscal year.
Seeking to reassure investors, the bank said in a statement it would not finance government borrowing and would use its policy interest rate to forestall any danger of inflation rising above a five-year target of 5 percent.
"There has been concern voiced in the media about a re-run of the instability of 2011, especially because of fears of election related public spending, and these concerns may be contributing to the pressure on the exchange rate," it said.
The government last week asked parliament to raise spending for the year ending in June by 5.3 percent. Parliament, dominated by President Yoweri Museveni's ruling party, is expected to approve the additional spending.
Critics say the cash aims to build support before the parliamentary and presidential polls when Museveni, in power for three decades, is expected to run again.
The government says it will use the money to improve security and for other state requirements, not campaigning.
Inflation stood at 1.4 percent year-on-year in February, slightly up from 1.3 percent in January.
In 2011, inflation soared to 30 percent, driving the shilling lower and forcing the central bank at the time to ramp up interest rates to 23 percent. (Writing by Edmund Blair; Editing by Drazen Jorgic and James Macharia)