Drop in fuel prices signals return to single digit inflation

The energy regulator’s announcement of a drop in fuel prices by the biggest margin, since Kenya started controlling the cost of petroleum products, has tipped the scales in favour of a return to single digit inflation, analysts said.

A significant drop in headline inflation, which stood at 10.05 per cent last month, is in turn expected to add downward pressure on interest rates, which began their own climb-down early this month with a 1.5 percentage points cut in the benchmark Central Bank Rate (CBR).
The Energy Regulatory Commission (ERC) on Saturday cut the maximum price of a litre of super petrol in Nairobi to Sh108.39 from Sh117.67 while reducing that of a litre of diesel to Sh97.50 from Sh105.51.

The new prices are linked to the recent fall in crude oil prices to an average of $97.35 a barrel in June from $110.51 in May and $126.99 in March.

Analysts at Citigroup said they expect a further drop in oil prices this month, a trend that could see further cuts in fuel prices next month.
It is expected that the fall in petroleum prices together with the continuing drop in food, transport and electricity expenses could push monthly inflation to

the single digit zone this month, having fallen for the seventh month in a row from its peak of 19.72 per cent last November.

A drop in crude prices supports the Kenyan shilling against the US dollar because oil marketers require less greenbacks to import petroleum — lowering the country’s import bill. Petroleum remains Kenya’s largest import item that accounts for about 27 per cent of the total bill.

“There is a stronger case for CBK (Central Bank of Kenya) to continue easing its monetary stance now that the shilling is stable and inflation on a downtrend,” said Razia Khan, head of Africa research at Standard Chartered Bank.

The Central Bank on July 5 eased its tight monetary stance by cutting the policy rate to 16.5 per cent from 18 per cent, signalling banks to lower lending rates as it became clear that expensive credit weighed down on the economy in quarter one.

The CBK has maintained a tight monetary stance since December -- retaining the Central Bank Rate (CBR) at 18 per cent, arguing that it needed to curb the flow of money in the economy to rein in inflation by reducing demand for imports. As a result, interest on bank loans increased to above 25 per cent from an average of 14 per cent in the first half of last year, keeping the banking sector’s total loan book stagnant at Sh1.2 trillion between September to April 2012.

This helped cut economic growth in the three months to March to 3.5 per cent compared to 5.1 per cent in a similar period a year earlier. The performance broke with past a trend when growth has been tied to Agriculture, which grew 2.3 per cent compared to 0.2 per cent last year — a pointer to the fact that high interest rates slowed down activities in the construction, manufacturing and finance sectors.

Recent stabilisation of the exchange rate at between Sh84.7 and Sh86 compared to a low of Sh107 to the dollar at the end of last year and the successive drop in inflation has, however, prompted the review of the tight monetary policy stance.

So far, Barclays Bank, Standard Chartered Bank, CFC Stanbic Bank, Bank of Baroda and Commercial Bank of Africa are part of the lenders that have cut their base rates by 1.5 percentage points. Analysts at Kestrel Capital say that other top banks like KCB Group, Equity Bank and Co-operative Bank are expected to review their rates downwards as the battle for borrowers intensifies.

The significant fall in the cost of fuel has wide implications on Kenya’s economy. Households will spend less on their energy needs and could also ease transport costs boosting their purchasing power to spend more on other items like airtime, beer and clothing.

Increased consumer spending power is critical to the plight of most producers who are struggling to push sales in a weak economy — which has seen six Nairobi bourse listed firms issue profit warnings from two last year.

The price of kerosene per litre, a major item in the budgets of poor households, dropped to Sh74.40 from Sh83.20. Gas prices have also dropped 30 per cent since December while Kenya Power has announced lower electricity prices in line with the cheap fuel that has reduced the cost of running diesel power plants.