Kenya surprises market with significant hike in rates

In another surprise move the Monetary Policy Committee of the Central Bank of Kenya raised interest rates again by 150 basis points to 11.5%. This follows a surprise hike in June (in a meeting held before scheduled) of the same magnitude. The committee noted that the move was done as a need to anchor inflationary expectations. The Kenya Bank Reference Rate (KBRR) was raised to 9.87% from 8.54%.

Inflation rose slightly in Kenya to 7.03% in June 2015 from 6.9% in May. Again inflation was driven by food prices (biggest portion of CPI basket) which rose by 13.39% y/y from 13.2% in May. Fortunately on a monthly basis food prices declined slightly between May and June as the recent, and long overdue, rains have produced a decent harvest. Transport prices are still benefiting from the high base effects in the previous year and registered -3.02% y/y. However this is expected to reverse as the year continues provided that oil prices remain within the $60 - 65 price range potentially adding up to 30% to petrol price inflation by year end (oil prices are currently $57).

The committee noted that there were some underlying demand-driven inflationary pressures like the non-food-non-fuel inflation rate increasing to 4.6% in June from 4.2% in May. They remain concerned about the pass-through effects from the recent depreciation of the Kenya Shilling (KES) against the US Dollar (USD).

The current account deficit has widened, even with lower oil prices, as the increase in capital imports has increased and exports continue to underperform. Foreign reserves are at USD 6.63 billion, which equates to 4.2 months import cover, a level which the central bank feels is adequate. The precautionary facility provided by the IMF is available should reserves fall under pressure.

The Kenyan economy expanded by an estimated 4.9% in the first quarter of 2015 which was higher than the 4.7% recorded in the same period last year. Construction grew at a slower, but still healthy, rate of 11.3% y/y down from the previous 19.4%. Tourism, which is an important source of foreign exchange for the Kenyan economy, contracted by 7.5% y/y from 16% in the previous quarter. This clearly shows that travellers are still concerned about security issues in the region.

Going forward, the Central Bank of Kenya is being more proactive in terms of maintaining price and currency stability as opposed to 2011 where they were caught behind the curve. It is important to remember however that domestic loans are referenced to the KBRR and this is the first change in the KBRR since January 2015 so there should theoretically have been no significant change in lending rates. The total increases in the interest rate have equated to 300 basis points in the last two months and at this point it seems as if the possibility of more hikes exists.

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