Yesterday, the Central Bank of Kenya’s Monetary Policy Committee reduced the Central Bank Rate (CBR) from 18 percent to 16.5 percent after the committee noted improvements in inflation and the local currency’s US Dollar exchange rate, a press release by the CBK revealed.

Last month, Kenya’s inflation declined Kenya hit its lowest inflation rate in more than two years declining 2.17 percent from May to reach 10.07  percent, according to the Kenya National Bureau of Statistics.

The CBR, which is the rate at which the Central Bank of Kenya loans money to local commercial banks, had been maintained at 18 percent since the beginning of December last year when the MPC raised it from 7 percent in September to quell inflation which had reached a two year high of 19.7%.

Further incentive to increase the CBR to 18 percent last year was to boost the Kenya Shilling which was waning against the US dollar, exchanging as low as KES 107 to the dollar in October compared to an average of KES 89 in July last year (CBK).

Lower Interest on Commercial Bank loans

According to Samora Kariuki, a Research Analyst at NIC Capital Securities, yesterday’s reduction in the CBR may have be a positive thing for the cost of commercial bank loans, but subject to the operations that the CBK has been conducting to manage the economy’s money supply.

“If they (CBK) continue to drain liquidity out of the system, then interest rates charged on commercial lending will not decline and secondly, commercial activity will not pick up rapidly.” Samora said.

To tame the economy’s inflationary money supply, the CBK has this year utilized repurchase agreements and term auction deposits, mopping up Ksh 3.6 billion from the economy just last week, a CBK bulletin showed.

In October last year, the Monetary Policy Committee increased the CBR by the biggest margin of the year, moving it up more than 5oo basis points(5%) to 16.6 percent and subsequently to 18 percent in December.

Soon after, average commercial bank lending rates increased from 15.21 percent last October to 20.34 in March this year, according to a report by the MPC released in April this year. To help borrowers cope with the increased commercial loan interest, the Ministry of Finance, Central Bank and Kenya Bankers Association implemented measures such as extending loan tenors and capping loan interest at 20 percent (Kenya Bankers Association).

Samora added that the Kenya economy operates with an estimated 9 month lag, meaning the effects of last year’s monetary tightening may still be experienced for months to come.

Value of  Kenya Shilling

The Lowering of the CBR yesterday may cause the Kenya Shilling to lose exchange rate value according to Samora, saying “I think the currency will over-react in the short-term (1-2) weeks but will regain ground longer term due to the fact that the monetary policy is still tight.”

Latest data from the CBK shows the Kenya Shilling is exchanging at KES 84.5 to the US Dollar.