Central Bank of Kenya (CBK) has raised its benchmark interest rate to 13%, the highest level since 2012 to curb inflation and stabilize the shilling. The move, which was unexpected by most analysts, sent bonds tumbling and boosted the currency.
The Monetary Policy Committee (MPC) increased the rate by 50 basis points from 12.5%, citing the need to address the persistent inflationary pressures and the exchange rate depreciation that have threatened the country’s macroeconomic stability.
“The risks to inflation remain elevated in the near term, reflecting the impact of second-round effects of the rise in fuel inflation, and pass-through effects of exchange-rate depreciation,” CBK Governor Kamau Thugge said in a statement.
“The MPC noted the continued, albeit reduced, pressures on the exchange rate and therefore concluded that further action was needed to stabilize prices.”
The Recent Rate Hikes Under Thugge
The rate hike, the third since Thugge became governor in June 2023, is the seventh in the current tightening cycle that started in May 2022 and brings the total combined increases to 600 basis points.
CBK has been one of the most aggressive central banks in the region in raising rates to combat inflation, which has been above the 5% target midpoint since November 2020.
The moderator said it expects the rate hike to anchor inflation expectations and set inflation on a downward path toward the target range of 2.5% to 7.5%.
It also said it will continue to monitor the impact of its policy stance on the economy and take additional measures as necessary.
The Surprise Move
The rate hike came as a surprise to most economists, who had expected the CBK to hold rates steady or increase them by a smaller margin.
According to a Bloomberg survey, only two out of eight analysts had predicted a 50 basis point hike, while the rest had forecast no change or a 25 basis point increase.
The CBK’s decision was also contrary to the trend of monetary easing seen in other emerging markets, such as Turkey, Brazil, and Russia, which have cut rates in recent months to support their economies amid the global slowdown and the coronavirus pandemic.
The CBK’s hawkish stance reflects its concern over the inflation outlook, which has been driven by the surge in global oil prices and the depreciation of the shilling.
The headline inflation rate rose to 6.9% in January 224, the highest level in more than two years, mainly due to the increase in fuel and transport costs.
Kenya Shilling Depreciation
The shilling has been one of the worst-performing currencies in Africa, losing almost 25% of its value against the dollar since the beginning of 2022.
The currency has been under pressure from the widening current account deficit, the decline in foreign exchange reserves, the weak external demand, and the political uncertainty ahead of the 2024 general elections.
The CBK has intervened in the foreign exchange market several times to support the shilling, but its efforts have been limited by the low level of reserves, which currently stands at $7.2 billion as at the end of January 2024, equivalent to 3.8 months of import cover.
The rate hike boosted the shilling, which gained 0.3% against the dollar on Tuesday, closing at 160.62.
The currency has appreciated by about 2% since the beginning of the year, helped by the inflows from the International Monetary Fund (IMF) and the World Bank, which have approved new loans for Kenya to support its economic recovery and fiscal reforms.
However, the rate hike also weighed on the bond market, which saw a sharp sell-off as investors demanded higher yields to compensate for the higher borrowing costs.
The yield on the 10-year eurobond due 2032 rose by 1 basis point to 10.54% on Tuesday, according to Bloomberg pricing. The yield on the 10-year domestic bond also increased by 10 basis points to 16.29% at the last auction on January 29.
The CBK’s policy tightening is expected to have a negative impact on the economic growth, which has already been hit by the effects of the pandemic and the containment measures.