Kenya Keeps Central Bank Rate at 7%
On May 27, 2021, the Central Bank of Kenya (CBK) announced that it would be keeping its interest rates — or Central Bank Rate (CBR) — at 7%.
In today’s post, we will be discussing why the interest rate matters and why the CBK decided to keep interest rates at 7%.
First, we need to discuss monetary policy.
Monetary policy consists of decisions and actions taken by the central bank to ensure that the supply of money in the economy is consistent with growth and price objectives set by the government.
The objective of monetary policy is to maintain price stability in the economy. Price stability simply refers to the maintenance of low and stable inflation.
Inflation is a persistent rise in the average price level of goods and services over a period of time. The CBK aims to keep inflation between 2.5%–7.5%.
How does the interest rate help to manage inflation?
There is an inverse relationship between inflation and interest rate. This means that the lower the interest rate, the higher the inflation. This relationship exists because as interest rates are reduced, more people are able to borrow money and consequently, consumers have more money to spend. The increased demand by consumers will cause prices to rise, leading to inflation.
High inflation can be curtailed by increasing the interest rate. This would make government securities, such as bonds, to be more attractive and cause a switch from spending towards investments, thereby, easing inflationary pressures.
Why did the CBK decide to keep its rate at 7%?
The simple answer is that the inflation rate in Kenya is within the CBK’s limit of 2.5%. The inflation rate stood at 5.8% in April.
Can the CBK really use the CBR to stimulate the economy?
To answer this question it is relevant to discuss the two types of inflation.
Demand-pull inflation is caused by demand from consumers, causing the price of goods and services to increase. Indeed, this is when monetary policy is most effective at controlling inflation.
The other type of inflation is cost-push inflation. This is caused by an increase in the cost of production of firms in the country. The increased cost of production will lead to a rise in the prices of goods and services i.e. inflation.
Kenya has cost-push inflation. This means that the CBK’s policies may be ineffective at controlling inflation in the long-term.
Indeed, Reginald Kadzutu — an economic analyst and acting CEO of Amana Capital in Kenya — stated that “the CBK has no effective transmission mechanism and so adjusting the CBR is an exercise in futility… The current inflationary pressure is cost-push which again CBK has no tools to deal with.”
Kenyan Central Bank Website