The Central Bank of Kenya's monetary policy committee (MPC) faces a tough test this week making a decision on the benchmark interest rate and stimulating economic recovery amid elevated inflationary pressure, which hit a 62-month high last month.
The MPC, which usually sits every two months, will this Thursday signal banks to either hold or raise borrowing costs. The pronouncement will come at a time the economy is projected to start recovering from a five-month softening streak that followed a bruising presidential poll amid soaring prices for households and businesses.
Analysts say the MPC, primarily tasked with maintaining price stability, will be expected to strike a balance between fighting runaway inflation and supporting output as well as demand by sustaining growth in credit flow to the private sector.
Industry lobby Kenya Bankers Association expects the CBK to hold its policy stance steady, largely citing expectations of falling fuel prices in coming months and a slowdown in economic activity.
“Sustaining the current monetary policy stance is warranted to anchor inflationary expectations and at the same time protect the ongoing economic recovery,” KBA research analysts wrote in a note last Friday.
“This is particularly important with enhanced optimism about the performance of the economy following the peaceful conduct of the General Election in August and the smooth transition in government.”
Economic activity grew 7.5 percent in the first quarter, but private sector data suggested a downturn in the second and third quarters.
Companies have reported a drop in output for six straight months through August on flagging sales, which dipped for five months in a row, according to Stanbic Bank Kenya’s Purchasing Managers Index (PMI), pointing to softer circulation of cash.
Annualised growth in credit to the private sector, on the other hand, fell for the first time this year in August, according to the CBK data, reflecting the negative influence of the closely contested General Elections on business activity.
KBA analysts fear tightening of the monetary stance will further stifle growth in credit uptake at a time the CBK is increasingly approving risk-based loan pricing models for commercial banks, enabling lenders “to take up more risk given their ability to alter risk premiums in loan prices”.
The MPC last raised the benchmark central bank rate (CBR) — a signal for direction in interest rates — on May 30 to “anchor inflation expectations due to increased global commodity prices and supply disruptions.”
The increase in CBR to 7.5 percent from 7.0 percent, where the rate had been stuck since April 2020, came a month before inflation punched above the upper limit for the first time since August 2017.
The cost of living measure has since breached the upper limit of 7.5 percent for three months on the trot through August when it climbed to a 62-month high of 8.5 percent.
During its last monthly meeting in July, the CBK retained its policy stance at 7.5 percent on the expectations of inflation moderating due to subsidies on fuel and maize flour, waiver of duty and levies on maize imports and halving of value added tax (VAT) on liquefied petroleum gas to 8.0 percent.
Inflation, however, continued to rise partly on failed maize flour subsidy, with further uptick expected this month after President William Ruto removed subsidies on petrol, and cut the reliefs on diesel and kerosene.
“When subsidy is removed prices will rise… and, therefore, that will be reflected in inflation. There will be knock-on effects,” CBK Governor Patrick Njoroge told lawmakers Monday last week.
“The bottom line is that subsidies are generally temporary… [because] with time they end creating serious distortions in the market.”
Dr Ruto has said the fuel subsidies, first tapped in April 2021, were unsustainable and that his administration will fully drop them in the coming months.
“We estimate that the price increases will push up headline inflation… by 0.6 percentage points. That will add to the headwinds facing Kenya’s economy,” Jason Tuvey, senior emerging markets economist at UK-based Capital Economics, wrote in a note on Kenya.
“Even so, the slashing of subsidies will be welcome from the perspective of Kenya’s public finances.”
Kenya’s inflation is largely driven by food and fuel costs which in August rose 15.3 percent and 8.6 percent year-over-year, meaning tightening monetary policy stance will likely not have an immediate direct impact in dealing with such price pressures.
However, non-food and fuel inflation — core inflation — also rose to 3.2 percent in August from 2.9 percent in the prior month.
“The contribution of core inflation to year-on-year overall inflation has been low and stable, consistent with the muted demand pressures in the economy on account of prudent monetary policies,” the Treasury wrote in the draft budget review and outlook paper earlier this month.
“The contribution of core inflation to overall inflation remained stable at 1.0 percentage points in August 2022 compared to 0.9 percentage points contribution in August 2021.”
