Shilling weakens after Central Bank retains interest rate

Central Bank of Kenya’s decision to hold its benchmark interest rate piled pressure on the shilling, which slipped to 91.20 units against the dollar from Wednesday’s average exchange rate of 90.40.

The banking sector regulator held the Central Bank Rate at 6.25 per cent following its bi-monthly meeting on Wednesday, against analysts’ expectations of a rate hike to support the weakening currency.

The Monetary Policy Committee, CBK’s top policy advisory organ, argued that any more rate increase to curb inflation would be counter-productive to economic growth as the rising commodity prices were mainly driven by commodity shortages and not over-supply of money. CBK said growth of money supply was below target since September last year.

“The shilling has weakened mainly due to failure by CBK to adjust rates upwards,” said Wilson Mutahi, a dealer at ABC Bank.

He said that raising interest rates would suppress availability of loans. The market had anticipated that CBK would slightly increase lending rates to commercial banks in a move to control inflation, but the regulator focused on sustaining growth choosing to hold the rate.

Dealers said increased demand for diesel powered generators and fuel from abroad to mitigate the impact of power rationing by Kenya Power will increase dollar demand, weakening the shilling further.

Analysts at Cooperative Bank of Kenya said high demand for imported maize was one of the factors that will continue to negatively affect the local currency.

High fuel prices on the global market will also continue to pile pressure on the shilling, increasing the country’s dependence on imports.

Crude oil prices were yesterday trading at $117 per barrel, just $4 shy of the record $121 it touched last April. Dealers, however, said inflows from tea will help support the currency but the bias is towards a weak shilling.

Slackening demand for horticultural exports in Europe is also expected to reduce inflows in the near term.

Demand

A weak shilling has softened demand for imported commodities such as cars, especially in the second quarter of this year, reducing business activity among dealers while leading to increased prices of basic imported commodities.

The shilling also lost against other major currencies such as the euro and the sterling pound which benefited from a weakening dollar over fears that rating agencies would revise US’ triple A credit rating downwards. In its May meeting the committee reviewed the CBR upwards to 6.25 from six per cent in a move expected to “tame the inflation rate and stabilise the exchange rate”.

High interest rates could result in the government having difficulties in financing its programmes while choking the economy as the shilling continued to cede ground against major currencies. This forced the bank to introduce a discount window rate which was to be reviewed daily.

Further rise in the rate could be harmful since the banks are facing liquidity crises. The security rates have risen to levels that players believe will attract foreign inflows and stabilise the shilling based on demand.

“You can’t tighten further due to risk of slowing down the economy, “ said Alexander Muiruri of African Alliance.