NAIROBI, Aug 30 – Kenya’s central bank has managed to cool sky-high money market interest rates with its latest policy adjustment, but analysts say it still faces a struggle to restore market confidence and stem weakness of the Kenyan shilling.
Policymakers have been on the defensive since January when the central bank cut its benchmark lending rate in a bid to keep interest rates down — just as inflation started to surge.
Eight months and two smaller-than-expected interest rate rises later, inflation is running at 16.7 percent, the shilling has hit a record low against the dollar, bond yields have rocketed and private analysts’ economic growth forecasts for 2011 are being trimmed.
The central bank’s latest move — changing the way it calculates the rate at its discount window, used to lend to banks in emergencies — has caused that rate to plunge to 19.8 percent from 31.4 percent seen on Friday, when the change was announced.
This promises to ease a funding crunch in the money market. Average interbank lending rates, which fell about 1 percentage point to around 27.7 percent on Monday, are expected to fall sharply to below the new level of the discount rate. Bond yields have also started to ease, with two-year yields down between 50 and 70 basis points this week.
But analysts worry that the root of the markets’ volatility, a crisis of confidence in policymaking in a country which has traditionally been viewed as one of Africa’s most stable and sophisticated economies, has not been fully addressed.
“In the last couple of weeks it seems like the central bank has been either taking measures to suck up domestic liquidity or tighten monetary conditions without hiking rates and sending a wider tightening signal,” said Stuart Culverhouse, head of research at frontier markets brokerage Exotix.
“The effect may be bringing some stability but it is failing to recognise the wider confidence crisis about the currency and the central bank.”
“UNPREDICTABLE AND INCONSISTENT”
To stem the slide of the shilling, which hit an all-time low of 95.10 to the dollar on Aug. 9, the central bank sucked liquidity out of the domestic money market in an effort to stop traders taking positions against the currency.
But a byproduct of that policy was a surge of interbank lending rates to crippling highs above 30 percent last week, prompting the finance minister to urge the central bank publicly to restore stability to monetary policy.
Last Friday, the central bank responded by adjusting the way it calculates the discount window rate and by giving banks more flexibility to meet cash reserve ratios — its fifth adjustment to the discount rate or lending rules since June 29.
Finance Ministry and central bank officials have been meeting this week to come up with further policy responses. Some official sources said it was possible the central bank would resume injecting liquidity into the money market through reverse repurchase agreements.
“Unpredictable and inconsistent monetary policy has negatively impacted foreign investors’ perceptions of Kenya,” said Matthew Searle, sub-Sahara Africa analyst at Business Monitor International.
By David Clarke
Source: Reuters Africa newsletter
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