The jump in cost of living in Kenya has caught the eye of the International Monetary Fund (IMF), which is now asking the Central Bank of Kenya (CBK) to consider tightening the base rate further to limit spillover effects such as demand for higher wages by workers.
The CBK raised its base rate by 0.5 percentage points to 7.5 percent in its last Monetary Policy Committee (MPC) meeting at the end of May, citing elevated risks to the inflation outlook following a global rise in food, supply chain and energy prices.
At the time of the rate change, inflation stood at 7.08 percent but subsequently rose at the end of June to 7.9 percent, breaching the upper limit of the CBK’s preferred range of 2.5 to 7.5 percent.
The IMF is now concerned that this rise in food and energy prices will spill over to other goods and services —known as second-round effects— particularly fuel prices that have a big pass-through effect on transport costs.
This is why the IMF Executive Board, sitting this week to review Kenya’s three-year $2.4 billion credit facility flagged inflation as a concern, noting that there are several outstanding risks such as the continuing war in Ukraine, drought in the semi-arid regions, unsettled global financial market conditions and political noise around the General Election.
As such, the IMF expects headline inflation to hold above the preferred range this year, before easing back within the band in early 2023.
“The Central Bank of Kenya’s recent monetary policy tightening is welcome. The CBK should stand ready to continue to adjust its stance to limit second-round effects from higher food and fuel prices and to keep inflation expectations well-anchored amid a temporary increase of inflation above the target band,” said Antoinette Sayeh, IMF deputy managing director and acting chair of the board.
Increasing the base rate has the effect of raising the cost of credit in the economy as banks adjust their rates upwards in tandem, reducing spending and tempering the growth of consumer prices.
The fund also reiterated its stance on the shilling, urging the CBK to ensure that “forex interventions (are) limited to addressing excessive volatility” so that the exchange rate can continue to function as a shock absorber against the current global shocks.
The shilling has weakened by 4.4 percent against the dollar this year, currently exchanging at 118.38 units to the greenback.
Dealers have said the regulator has largely avoided dollar sales into the market of late, despite calls to step in from some importers whose costs have shot up due to exchange losses.
The CBK’s stance is that it does not seek to influence the direction of the exchange rate, but only steps in to smooth out volatility.