CBK faces pressure to hike interest rates

The Central Bank of Kenya (CBK) is facing pressure to raise interest rates at its next Monetary Policy Committee (MPC) meeting on Thursday.

The pressure to raise the benchmark lending rate from the current 7.5 points stems from higher interest rates in developed economies, which has triggered portfolio outflows by foreign investors from emerging and frontier markets.

Continued rate hikes this week by the United States (+0.75%) and Switzerland (+0.75%) is expected to exacerbate the outflows compounding on not just financial flows into the country but also the exchange rate.

According to analysts at Genghis Capital, the CBK must now counter the risks posed by higher interest rates in the developed markets by raising its own benchmark rate to cushion against portfolio outflows.

“To achieve stickiness in capital flows and counterbalance rate rises in the US and Europe, emerging markets must now premiumize returns on domestic assets,” the analysts stated.

“Essentially, an investor holding USD, currently yielding at the base rate of 2.5 per cent and looking to invest in Kenya Shillings denominated assets should earn an interest premium of 6.6 per cent over current KES interest rates.”

With the US Federal Reserve and the European Central Bank (ECB) tipped for further rate hikes before the end of this year, the analysts have called for the countering of the expected hikes by edging local interest rates upwards.

Analysts at Sterling Capital on the other hand do not anticipate further rate hikes by the CBK in 2022 arguing the increases would not yield in lowering inflation which is the reserve’s bank immediate headache at achieving price-stability.

“Revision of the CBR has minimal impact on managing Kenya’s inflation as it is driven by supply cost pressure rather than excessive demand on money supply,” they stated.

The CBK raised its benchmark rate by 0.5% per cent at the end of May to anchor inflation expectations.

Inflation has nevertheless hit 8.5 per cent to stand above CBK’s ceiling of 7.5 per cent informing the need for recourse by the apex bank to assure price stability.

In appearances on CNN and Bloomberg TV earlier this week, CBK Governor Patrick Njoroge said the reserve bank remained primarily focused on managing inflation and inflation expectations as the priority over cushioning the exchange rate and capital flows.

While higher interest rates may cushion against further portfolio outflows, hiking the benchmark interest rate would result in greater borrowing costs for not just household and firms but also government.

Short-term domestic debt interest rates have for instance risen by between 40 and 85 basis points in the first half of 2022 on the revision of the Central Bank Rate (CBR).

Bank deposit and lending rates have also increased in tandem with the benchmark interest rate lift.