The high cost of living has emerged as the first real test for new Central Bank of Kenya (CBK) Governor Kamau Thugge’s tenure, going by the regulator’s swift move to raise the base lending rate in a bid to arrest a new round of price increases in the economy.
Dr Thugge sought to explain on Tuesday that an unexpected jump in non-food-non-fuel inflation—otherwise known as core inflation—in May was primarily behind the Monetary Policy Committee’s (MPC) decision on Monday to raise the base lending rate by 100 basis points to a seven-year high of 10.5 percent.
Core inflation tends to be less elastic compared to headline inflation, which is influenced by the volatile change in food and fuel prices. The CBK’s monetary policy normally has more impact on core inflation.
An increase in core inflation is indicative of deeper price issues in the economy, and that the price rise in the primary products (food and fuel) is filtering through to other segments such as transport, healthcare, manufacturing, recreation and education services.
The CBK, whose key mandate is maintaining price stability in the economy, has been wary of the second-round effects of inflation, which have the potential of derailing economic growth by reducing productivity and consumption of a wide range of goods and services.
“Fighting second-round effects is precisely what we are trying to do with the increase of CBR from 9.5 percent to 10.5 percent. We are very concerned about the trend in non-food-non-fuel inflation, which for some time has been below three percent but has now climbed to 4.3 percent,” said Dr Thugge in a post-MPC briefing.
“Inflation is almost like a tax because it reduces everybody’s real income. Therefore, it is very important that we address the inflationary pressures with the idea of reducing the cost of living, which is one of the issues that has concerned the country.”
He said core inflation of about three percent is consistent with overall inflation of five percent, explaining why the MPC took strong measures after it breached the four percent level.
The high cost of living is one of the issues causing a headache for the Kenya Kwanza administration, especially in light of the public outcry against the impending tax rises and increase in statutory deductions following the passing of the Finance Act 2023.
The previous MPC meeting held towards the end of May had painted a rosier picture of Kenya’s inflation situation, projecting a fall to 7.1 percent that looked set to give the government some breathing room as it brought up its higher taxation measures.
That outlook was, however, based on April inflation data, which had shown a fall in headline inflation to 7.9 percent from 9.2 percent in March. Core inflation had also retreated to 4.1 percent from 4.4 percent.
The May numbers, which became available after the MPC had made its decision and projections, however, painted a different picture, where headline inflation rose to eight percent, and core inflation to 4.3 percent.
“The internal projections were that the near-term inflation would continue to decline…given the information that they had, it made sense not to further tighten monetary policy,” said Dr Thugge.
An agriculture sector survey earlier this month also informed the MPC that there were expectations in the economy of a rise in prices, mainly due to higher input and transport costs.
In the June survey, 61.1 percent of respondents told the CBK they expect higher inflation in the next month, up from 44.4 percent of respondents in a similar survey done before the May MPC meeting, while the share of those projecting a fall in consumer prices fell from 25.5 percent to 11.1 percent.
Similarly, projections covering the next three months show those anticipating higher prices rising to 54.2 percent from 42.5 percent, while those projecting lower inflation fell from 43.8 percent to 26.4 percent.
“It was critical that we take action to address this change in inflationary expectations and hopefully anchor those expectations so that people don’t make decisions on the basis of expecting inflation to fall,” said the CBK governor.
Going forward, the CBK is also wary of renewed inflationary pressure due to the changes in taxes via the Finance Act 2023, particularly the increase in VAT on fuel to 16 percent from eight percent.
Dr Thugge said that the CBK expects that the VAT change will have an impact on inflation in July, even as he argued that the corresponding cut in the Railway Development Levy (RDL) and Import Declaration Fees (IDF) will mitigate some of the effects.
The governor said however that due to the measures the CBK is taking, such as the rate hike, the MPC expects that by August or September at the latest, inflation will have eased to below the preferred ceiling of 7.5 percent.
