Market analysts predict that the Central Bank of Kenya (CBK) will reduce its benchmark interest rate by 0.5 percent during today’s Monetary Policy Committee (MPC) meeting, potentially bringing the rate down to 12.25 percent. Such a move would be aimed at boosting economic growth by easing borrowing conditions for businesses and individuals. This rate reduction is driven by several favorable economic indicators, including declining inflation rates, a stronger Kenyan shilling, and a global shift towards looser monetary policies.

Drivers Behind the Expected Rate Cut

Economic Context and Global Trends
The anticipated rate cut aligns with the CBK’s ongoing efforts to stimulate economic recovery following a period of global and domestic economic turbulence. Emilio Munene, a macroeconomic analyst and bank economist at Equity Group Holdings, highlighted that the reduction reflects a broader trend of easing monetary policies in response to improving economic conditions. He noted that declining inflation, a strengthening Kenyan shilling, and trends in global monetary policy all point towards the need for lower interest rates in Kenya.

Global factors are also influencing the expected rate cut. Crude oil prices have declined significantly, from $83.26 per barrel in August to $72.42 per barrel in September. This has resulted in a 7.1 percent decrease in energy prices, which is a key contributor to lower inflation in Kenya. Additionally, many central banks globally, including the European Central Bank and the US Federal Reserve, have signaled shifts towards more accommodative monetary policies. These changes reflect a stabilizing inflationary environment and encourage economic growth, which puts pressure on the CBK to follow suit.

Domestic Economic Indicators
Domestically, Kenya’s inflation rate dropped to 3.6 percent in September, down from 4.4 percent in August. This marks the lowest inflation level seen in the country in nearly twelve years. The reduction in inflation has been driven by lower non-food and non-fuel price growth, as well as declining energy costs. Meanwhile, food inflation has risen slightly to 5.39 percent, but fuel inflation has decreased to 6.08 percent.

The appreciation of the Kenyan shilling, which has strengthened by 21 percent against the US dollar since the beginning of the year, has played a crucial role in lowering import costs and stabilizing the economy. As the value of the shilling has improved, the cost of importing goods, particularly energy-related products, has decreased, further contributing to the decline in inflation.

Investment bank Genghis Capital pointed out that the measures taken so far by the CBK have successfully brought inflation below the target midpoint. With inflationary pressures under control, there is room for the CBK to ease its monetary policy without risking a resurgence of inflation. Genghis Capital also noted that the Kenyan shilling’s recent appreciation has added to the stability of the economic environment.

Impact on Borrowing and Investment

Encouraging Borrowing and Consumer Spending
A reduction in interest rates would have significant implications for the Kenyan economy, particularly in terms of borrowing and investment. Lower interest rates typically make it cheaper for businesses and consumers to borrow money, which can lead to increased investment in new projects and expansion efforts. Consumers are also more likely to take out loans for major purchases, such as homes and cars, when interest rates are lower.

Emilio Munene commented that the anticipated rate cut would not only boost economic recovery but also incentivize borrowing, investment, and consumer spending. The reduction would be particularly beneficial for small and medium-sized enterprises (SMEs) that rely on affordable credit to finance their operations and growth. Increased borrowing and spending would help stimulate demand in various sectors, contributing to overall economic expansion.

Sector-Specific Effects

Performance of Key Sectors
While Kenya’s overall economic performance remains positive, with a GDP growth rate of 5.6 percent in 2023, there are signs of a slowdown. Growth in the first quarter of 2024 was 5 percent, the slowest rate since 2021. Several key sectors, such as information and communications technology (ICT) and financial services, continue to show robust growth. However, other sectors, particularly manufacturing, have struggled, growing by just 1.3 percent. This sluggish performance highlights the need for targeted interventions to stimulate activity in underperforming industries.

The private sector’s Purchasing Managers’ Index (PMI), a key indicator of business activity, fell to 49.7 in September, indicating a slight contraction. Despite this, many firms are increasing their purchasing activities to build inventories, suggesting optimism for future growth. However, business confidence remains low, with confidence levels recorded at their lowest in a decade. The combination of subdued private sector growth and low business confidence underscores the importance of the CBK’s monetary policy decisions.

Banking Sector Challenges

Rising Non-Performing Loans
One of the key challenges facing Kenya’s banking sector is the issue of non-performing loans (NPLs). High-interest rates have contributed to a rise in NPLs, which reached 16.4 percent in June, up from 16.1 percent in April. This increase in NPLs has been accompanied by a slowdown in private sector credit growth, which fell to just 4 percent in June, compared to 7.9 percent in March. As businesses and individuals struggle to repay their loans, banks face increased risks, which could further dampen economic growth.

By lowering interest rates, the CBK could help alleviate some of the pressure on borrowers, making it easier for them to meet their loan obligations. A reduction in NPLs would improve the health of the banking sector, allowing banks to extend more credit to businesses and individuals. This, in turn, would support economic growth by enabling more investment and consumption.

Global Context and External Influences

Global Monetary Trends
The CBK’s decision to potentially lower interest rates is also influenced by global monetary trends. Central banks around the world are gradually shifting towards looser monetary policies as inflation stabilizes and economic growth remains a priority. The European Central Bank, for example, has signaled a more accommodative stance in response to improving inflation trends in the Eurozone. Similarly, the US Federal Reserve has taken steps to adjust its monetary policy, reflecting stabilizing inflation and the need to support growth.

Kenya’s close ties to the global economy mean that these international trends are likely to impact domestic monetary policy. Lower interest rates globally make it more attractive for Kenya to reduce its own rates in order to remain competitive in attracting investment. Additionally, lower global interest rates can help ease the burden of servicing external debt, which is a significant concern for many developing economies, including Kenya.

Conclusion

As the CBK’s Monetary Policy Committee meets to discuss the potential reduction in the benchmark interest rate, all signs point towards a 0.5 percent cut. This reduction would bring the rate down to 12.25 percent, providing much-needed relief to businesses and consumers. By lowering borrowing costs, the CBK aims to stimulate investment, boost consumer spending, and support economic recovery.

With inflation under control, a strengthening shilling, and global trends favoring looser monetary policies, the CBK has room to ease its stance without risking a resurgence of inflation. However, challenges remain, particularly in the form of rising non-performing loans and slow growth in key sectors like manufacturing. The CBK’s decision will play a crucial role in shaping the trajectory of Kenya’s economic recovery in the months ahead.

photo source: Google

By: Montel Kamau

Serrari Financial Analyst

8th October, 2024