Experts see rising cost of fuel pushing up CBK lending rate

Rising fuel prices and prospects of a base rate increase in the US could push the Central Bank of Kenya (CBK) to tighten its monetary policy and reverse recent cuts in the base lending rate, analysts at Ecobank say.

The Energy Regulatory Commission (ERC) has raised fuel prices on four straight occasions starting with the May 14 review, due to increasing oil prices in the international market.

The higher cost of fuel filters down to items in the monthly expenses basket for households such as food, transport and energy.

Outside Kenya, there has been renewed talk within the US Federal Reserve of the possibility of a rate hike before the end of the year — which would strengthen the dollar worldwide — as US inflation stabilises.

A stronger dollar to the shilling and the need to prevent capital flight from Kenya to the US would add to the pressure on the CBK (and other emerging market central bankers) to raise its rate. “Rising petroleum costs will place upward pressure on inflation as energy and transport costs carry significant weights in the CPI basket.

‘‘The recent release of stronger-than-expected US economic data has boosted expectations that US interest rate hike is imminent,” says Ecobank.

“A US rate rise would lead to an outflow of capital from Kenya and put pressure on the shilling, which has remained broadly stable so far this year, in turn putting further pressure on prices.” Inflation has risen in Kenya from five per cent in May to 5.8 per cent in June and 6.4 per cent last month.

It still remains within the desired range of five per cent plus or minus 250 basis points and this was one of the reasons why CBK retained the base rate at 10.5 per cent in its last MPC meeting in July.

The fluctuation of signals coming from global financial markets in recent months have however led to differing outlooks from various economists and analysts on the possible direction of the base rate.

Standard Chartered chief economist for Africa Razia Khan said in her July markets note on Kenya the expectation is that there will be a rate cut in coming months, saying that inflation should remain within the desired range as some of the drivers will be temporary.

READ: Tough times for banks as Uhuru caps cost of loans

The narrowing current account deficit is also likely to help keep the shilling stable in the near term, as Kenya’s major infrastructure projects such as SGR near completion.

“The CBK now expects the current account (C/A) deficit to end the year at 5.5 per cent of GDP. While our own projection is for a slightly wider deficit, we nonetheless expect relative shilling stability to persist. This should favour a continued benign inflation outlook,” said Ms Khan.

The analysis by Ecobank and Standard Chartered did however not factor in the disruptive effect of the bank lending rate cap, which has now been signed into law by President Uhuru Kenyatta.

Through the new law, the CBR will also become the primary loan pricing tool for banks, something that the CBK will have to take into account when using it as a monetary policy tool to keep a check on inflation and currency weaknesses.