Central Bank of Kenya tightens monetary policy

CBK Tightens Monetary Policy

The MPC shifted the Central Bank Rate (CBR) upwards for the first time since May 2013 in a pre-poned meeting held last week. The Central bank which was revised upwards by 150bps to 10% from the previous 8.50% demonstrates a tightening bias in the monetary policy regimen.

Despite a lower level of inflation which came down to 6.87% in May 2015 from 7.08% in April 2015 owing to significant decreases in the prices of key food items on the onset of rains; the committee noted growing concerns of demand side pressures as underlying inflation (Non-Food Non-Fuel) has crept up over the last three months, recorded at 3.16% in March relative to 4.15% as of May.

The 12 month growth rate of broad money supply which was recorded at 16.57% in April 2015 was higher than the CBK non-inflationary target of 14.80%; indicating growing demand side pressures from increased circulation of money.

The MPC’s shift towards a tightening bias in monetary policy will aid to reinstate confidence in the money market as well as tame anxiety amongst cautious foreign investors as stringent measures and monetary policy operations are in place to prevent further exchange rate depreciation and maintaining price stability in the market.

On the flip side, a hike in CBR rate will inevitably result in a consequent rise in the KBRR in the following month, therefore signalling a rise in bank’s average lending rate which will consequently slow down the rate at which private sector credit growth is currently growing (19.89% as of April 2015 against a target of 19.43%) as banks are likely to feel a strain from a contraction in interest rates generated from loans.

Consequently, using the current CBR rate at 10% and a forecasted 3 month average for the 91day t-bill we expect the KBRR to hold within the range of 9.33%-9.48%.

Kenyan Shilling Remains Vulnerable to External Pressures

The Kenyan Shilling (KES) remained significantly volatile during the month of May, registering steep declines against major international peers. The USDKES exchange rate shed 3.57% and slid down by down by 2.80% and 2.05% against the Sterling Pound (GBP) and Euro (EUR), respectively.

Significant demand for foreign currency was one of the main internal factors for currency volatility, as medium sized corporates aimed to increase their stock of foreign exchange in hindsight of further volatility. We retain high expectations that the Dollar will continue to strengthen over the coming weeks as it rallies on the back of strong economic data. Latest data releases showed a rise in consumer sentiments whilst business inventories have tracked steady growth, all pointing towards a healthy economic recovery.

Furthermore, possibilities of a delay in the Federal rate hike may result in dollar strengthening over a prolonged period. Similarly, we expect the Sterling Pound to continue strengthening as economic fundamentals fuel optimism.

The CBR rate hike has so far helped to calm the Shilling’s decline by reinstating confidence in the money market as well as tamed anxiety amongst cautious foreign investors as stringent measures and monetary policy operations are in place to prevent further exchange rate depreciation. We portend USDKES exchange rate to trade within the range of 95.55-97.80 in the coming weeks.

Liquidity Constraints Continue to Dampen Trading Levels

The money market was plagued with liquidity constraints during the month of May and we have observed some effects filtering into the month of June. Liquidity was particularly tight in the second half of May as commercial banks paid taxes to the CBK and the monetary regulator issued OMO (Open Market Operations) securities to manage exchange rate volatility.

A sum of KES 31.2 billion worth REPOs and TADs were issued during May relative to KES 69.2 billion issued in the previous month. The month of June and July do not have any Treasury bond redemptions. We expect liquidity in the money market to remain relatively tight for the remaining part of FY 2014/2015, consequently the monetary regulator may not need to step into the market as frequently.

Nonetheless, we may see reactive measures and sales of OMO securities in periods of slight excess liquidity as the regulator keeps a close eye on the local exchange rate.

Treasury Yield Expected to Edge Up

Yields displayed a slight upward trend particularly on the short and medium term segment. Liquidity in the money market remained relatively tight resulting in subdued trading levels in the secondary market. Uncertainty of the direction in rates still looms over the market.

Following the CBR rate hike we portend further upward shift in yields. Liquidity constraints as well as borrowing needs as approach the end of FY 2014/2015 are likely to place further upwards pressure on yields across the board.

Due to uncertainty of a definite direction in yields and lack of assurance of the trend of the yield curve we expect investors to remain cautious whilst trading on the secondary market; and are likely to show preference for short term papers. Consequently, we portend a flatter yield curve as we close books for the current FY and gear up for the start of FY 2015/2015.