Currently, the Monetary Policy Committee (MPC) is meeting to discuss key macro-economic policy matters affecting Kenya’s economy. The Monetary Policy Committee is the organ of the Central Bank of Kenya responsible for formulating the country’s monetary policy.

A key item under review in today’s meeting will be the review of the CBR, or Central Bank Rate, which is the lowest interest rate that the CBK charges on loans to commercial banks.

According to the Central Bank’s website, the CBR ‘…serves as a signaling instrument for monetary policy’, adding that ‘…Monetary policy guards against inflation and ensures stability of prices, interest rates and exchange rates. This protects the purchasing power of the Kenya shilling and promotes savings, investment and economic growth.’

Since the MPC increased the Central Bank Rate to 18 percent at the beginning of December last year, inflation has reduced from 19 percent to just over 10 percent last month. Additionally, the Kenya Shilling Dollar exchange rate has improved by 6 Shillings in the same period (CBK), while the Nairobi Securities Exchange has been ranked the world’s third best performing for this year as of last month (Bloomberg). Meanwhile, Kenya’s economy showed the slowest growth rate in the first three months of this year since 2008 (KNBS).

With the above economic changes having taken place within seven months of the MPC’s Central Bank Rate increase to 18 percent, Pesatalk will examine possible economic outcomes that could happen if the MPC reduces the CBR in today’s meeting.

If MPC reduces Central Bank Rate from 18 percent

A survey done by Reuters had eight out of twelve analysts predicting that the committee would reduce the CBR today. Samora Kariuki, a Research Analyst at NIC Capital Securities said “It is expected that the MPC will start cutting rates…” while referring to the Central Bank Rate.

If this happens, Bank loans may have lowered interest rates, as commercial banks peg their loan interest rates on the CBR. Cheaper bank loans could lead to higher economic growth which has slowed during the first quarter of this year while the CBR has been at 18 percent according to the Kenya National Bureau of Statistics.

Commercial bank lending rates moved higher last year after the CBR was increased to tighten monetary policy according to a 2012 report by the Kenya Bankers Association.

To help alleviate the cost of loans on customers, the CBK, Ministry of Finance engaged in short-term actions such as extending loan repayment periods and capping loan installments at 20 percent according to the same report. The MPC has maintained the CBR at 18 percent since December last year and a reduction in the rate could see a similar effect with commercial bank loans which peg their commercial loan interest rates on the CBR.

If the MPC cuts interest rates, the Kenya Shilling could also face threatened performance against foreign currencies. The MPC increased the CBR to 18 percent in December ‘… to dampen the persistent inflationary pressures and stabilize the exchange rate.’ according to a report by the MPC dated April 2012.

Since then, the Kenya Shilling has gained to exchange at KES 84 against the US Dollar from KES 90 (CBK). Two months before, in early October 2011, the Shilling was exchanging at KES 100 to the US Dollar. The Kenya Shilling has exchanged below KES 90 to the US Dollar throughout the time the CBR has been at 18 percent.