The Central Bank of Kenya (CBK) may have saved the economy from an inflation crisis following its June increase in its benchmark rate.
But it must now face the consequences of its action at its policy-setting meeting on Wednesday after the higher rate translated into adverse effects for consumers.
While the apex bank has been widely tipped to leave the benchmark lending rate unchanged as the impact of its last policy decision continues to be felt, market participants have already warned of a downshift in credit growth.
The banking sector lobby represented by the Kenya Bankers Association (KBA) for instance says member banks have taken a cautious stance to lending as they monitor non-performing loans, which have partly been triggered by a liftoff in lending rates.
“The ongoing transmission of higher interest rate policy signals announced in late June 2023 continues to trigger cautious and tighter lending conditions by banks as the industry monitors the evolution of non-performing loans amidst elevated cost of living for borrowers and a slowdown in economic activity. This is expected to ease private sector credit growth in the economy. In the view of monetary policy tightening and the expected transmission, interest rates have edged up,” KBA said in a note last week.
Real interest rates, which describe the return on interest-yielding assets after inflation have firmly held in the positive after CBK’s last monetary policy tightening cycle in line with expectations.
But while the translation has been swift, analysts have warned that the high-interest rates could break the economy’s back, cautioning of the likelihood of a funding crisis.
“We anticipate positive real rates to weigh heavily on investment spending and real money supply growth, shocking output growth over the medium term. We think CBK should exercise a dexterous balance to avoid a systemic credit crunch that would severely constrain growth,” noted analysts at Genghis Capital.
Such an outcome would be tough for an economy which marked a sixth straight month of deterioration in business conditions as a result of declined cash flows for businesses according to data from July’s Stanbic Bank Kenya Purchasing Managers Index.
Inflation, which makes for CBK’s key indicator in the translation of the monetary policy stance has, however, eased to the targeted band of 2.5 to 7.5 percent informing the scope of leaving the benchmark lending rate unchanged.
However, the apex bank is seen as playing catch-up to its peers in advanced economies, aiming to close the interest rate differential with the view to making yields on domestic assets attractive to foreign investors.
“We think the CBK is playing catch-up with the US Federal Reserve- which had hitherto hikes its benchmark rate by a cumulative 500 basis points (five percent) compared to CBK’s cumulative 250 basis points (2.5 percent). As such the new regime capitalised on the scope for further tightening to achieve optimal interest differentials- stemming the Kenya shilling volatility in the process,” added the Genghis analysts.
The International Monetary Fund (IMF) has, however, backed a weaker local exchange rate to cushion the economy by driving up cheap exports even if this translates into costlier imports-a partly positive outcome in reducing overall demand in the economy.
As such, the CBK is presumed to be less eager to defend the local unit by taking on a tighter monetary policy stance (raising interest rates)
Analysts at AIB-AXYS Africa expect the CBK to adopt a wait-and-see policy at its rate meeting amidst sustained inflationary pressures following the green light on the implementation of the 2023 Finance Act.
“We foresee the MPC maintaining the CBR rate at 10.5 percent with the committee considering the impact of the previous raise,” they stated.
In raising the key lending rate in late June, the CBK noted the move was premised on anchoring inflation expectations in anticipation of the impact of new taxes.
July’s inflation rate fell to 7.28 percent falling within the government’s target band for the first time since May 2022.
