The Central Bank of Kenya (CBK) has announced a reduction in its base lending rate, lowering it from 12 percent to 11.25 percent, effective immediately. This decision was made during the Monetary Policy Committee’s (MPC) meeting on December 5, 2024, following a significant decline in global inflation and slower economic growth in the first half of the year. The move is designed to stimulate economic activity by making borrowing more affordable for businesses and individuals in the country.

Key Factors Behind the Rate Cut

The MPC highlighted several factors influencing its decision. The primary reason for the reduction was the continued decline in global inflation, which has been a significant factor in the easing of monetary policy by major central banks worldwide. The CBK noted that inflation in Kenya remained stable at 2.8 percent in November 2024, just slightly up from 2.7 percent in October, well below the midpoint of the targeted inflation range of 5±2.5 percent.

Furthermore, the central bank attributed Kenya’s stable inflation to non-food, non-fuel inflation, which showed a slight decrease to 3.2 percent in November from 3.3 percent in October. Despite a slight rise in food inflation—up to 4.5 percent in November from 4.3 percent in October—largely due to increased prices for cooking oil, overall price pressures remained manageable. Fuel inflation also remained subdued at -1.6 percent in November, reflecting the drop in fuel prices, especially electricity and pump prices.

The MPC also noted that the country’s inflation trajectory was expected to stay below the target range in the short term, aided by factors such as favorable weather conditions leading to improved food supply and lower fuel prices. Additionally, the exchange rate was stable, which contributed to the overall positive inflation outlook.

Implications of the Rate Cut

The reduction in the Central Bank Rate (CBR) is expected to have wide-ranging implications on the Kenyan economy. By lowering the base rate, the CBK is encouraging commercial banks to reduce their lending rates, which could lead to increased credit access for the private sector. This, in turn, is expected to stimulate economic activity, particularly in sectors that are sensitive to interest rates, such as construction, manufacturing, and trade.

The MPC emphasized that, despite the drop in short-term rates on government securities, banks had not yet passed on the full benefits of the reduced CBR to their customers. This situation prompted the CBK to urge commercial banks to adjust their lending rates in line with the new policy stance. If banks follow suit and lower their interest rates, consumers and businesses may find it easier to access credit for consumption and investment, potentially fostering economic recovery.

Impact on the Banking Sector

The CBK also addressed the stability of the banking sector, which has remained resilient despite the high interest rate environment. The sector’s strong liquidity and capital adequacy ratios were attributed to the reduced demand for foreign currency-denominated loans, largely driven by the relatively high interest rates. In October 2024, growth in local currency-denominated loans stood at 4.0 percent, while foreign currency-denominated loans—which account for around 26 percent of total loans—contracted by 11.8 percent.

The banking sector’s stability has been crucial for maintaining confidence in Kenya’s financial system, particularly given the global economic uncertainties. The CBK also highlighted that Kenya’s foreign exchange reserves remained robust, amounting to USD 8.97 billion, which covers 4.57 months of import cover. This level of reserves provides a sufficient buffer against potential shocks in the foreign exchange market.

Global Economic Context

The decision to lower interest rates also comes amid a broader global trend of easing monetary policies, as many central banks around the world, including the Federal Reserve in the United States and the European Central Bank, have been gradually lowering interest rates in response to falling inflation. This global environment has created a more favorable backdrop for Kenya to adjust its own monetary policy.

However, global inflation has not yet returned to pre-pandemic levels, and some regions are still grappling with the consequences of supply chain disruptions, energy price volatility, and the aftermath of geopolitical tensions, such as the ongoing Russia-Ukraine war. Despite these challenges, the general trend toward lower global inflation has given many central banks, including the CBK, room to adopt more accommodative policies to support economic growth.

Kenya’s Economic Growth and Outlook

Kenya’s economy faced slowed growth during the first half of 2024, a trend the CBK acknowledged in its statement. Economic activity was weaker than expected, especially in key sectors like agriculture, which had been affected by irregular rainfall patterns and high production costs. However, the second half of the year has shown signs of recovery, with improved agricultural output due to better weather conditions, and the economy is expected to gain momentum going into 2025.

The CBK’s decision to reduce the CBR is expected to provide some much-needed stimulus to the economy, particularly for businesses that are looking to expand and invest in the post-pandemic recovery phase. However, the government’s broader economic policies, including fiscal management, infrastructure development, and efforts to reduce the cost of doing business, will also be critical in ensuring sustainable growth in the medium term.

Challenges and Future Outlook

While the rate cut is a positive step for the economy, challenges remain. High levels of public debt and fiscal deficits continue to pose risks to Kenya’s financial stability. The government has been working on debt management strategies, but the country’s debt burden remains a significant concern. Furthermore, the business environment in Kenya faces challenges such as corruption, high production costs, and sometimes inconsistent regulatory policies, which could limit the effectiveness of the rate cut in spurring growth.

In the coming months, the CBK will continue to monitor both domestic and global economic developments closely. The central bank remains ready to adjust its monetary policy as necessary, depending on how inflation, growth, and other economic indicators evolve. The MPC’s next meeting is scheduled for February 2025, when it will reassess the situation and determine if further adjustments to the base rate are warranted.

Conclusion

The CBK’s decision to lower the base lending rate to 11.25 percent is a strategic move aimed at stimulating Kenya’s economy during a period of global inflation decline and slower growth. By making borrowing cheaper, the CBK hopes to encourage increased investment and consumption, which will support the recovery of key sectors like manufacturing, trade, and agriculture. However, the success of this policy will depend on the willingness of commercial banks to adjust their lending rates, as well as the government’s ability to address other underlying economic challenges. As Kenya moves into 2025, the country’s economic resilience will be tested, and the CBK’s ability to navigate the delicate balance between inflation control and growth stimulation will be crucial to its long-term stability.

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Photo source: Google

By: Montel Kamau

Serrari Financial Analyst

6th December, 2024