Kenya’s central bank has reduced its benchmark interest rate to its lowest point in almost two years, aiming to stimulate economic growth amidst low inflation. This move signals confidence in the country’s economic outlook and a proactive approach to supporting private sector lending.
The Central Bank of Kenya (CBK) lowered the key lending rate to 10.75% from 11.25%, as announced by Governor Kamau Thugge. This decision aligns with expectations from economists and reflects the CBK’s assessment of the current economic landscape.
Favorable Inflationary Environment Enables Rate Cut
The rate cut was made possible by sustained low inflation, which is projected to remain below the CBK’s 5% target. This favorable inflationary environment is attributed to several factors: stable core inflation (excluding food and energy), low energy prices, and a stable exchange rate. The Kenyan shilling has maintained a steady rate of 129 shillings per dollar for the past six months, contributing significantly to price stability. Inflation edged up to 3.3% in January from 3% in December, while core inflation, a measure of underlying price pressures, actually decreased to 2% from 2.2%. This indicates weak demand-pull inflation.
Supporting Economic Activity a Primary Objective
The CBK’s decision to lower the interest rate is also aimed at bolstering economic activity, which experienced a slowdown in 2024. While the economy grew by an estimated 4.6% last year, down from 5.6% in 2023, the CBK projects a rebound in 2025 with a growth forecast of 5.4%. The rate cut is expected to encourage borrowing and investment, thereby contributing to renewed economic momentum.
Global Uncertainty and Kenya’s Resilience
The CBK’s move comes at a time of global economic uncertainty, largely driven by policy shifts in the United States. However, Kenya’s economy has shown resilience, benefiting from factors such as strong foreign investment inflows, particularly in tax-free infrastructure bonds. Furthermore, program inflows from international institutions like the World Bank and the International Monetary Fund, along with access to a substantial loan from Abu Dhabi, are expected to strengthen Kenya’s foreign exchange reserves.
Addressing External Debt and Encouraging Lending
Despite these positive factors, Kenya faces challenges related to its external debt burden. Significant payments are due in the current fiscal year, requiring substantial borrowing to cover the budget deficit.
To further stimulate economic activity, the CBK also reduced the cash reserve ratio for banks by 100 basis points to 3.25%. This measure is intended to lower the cost of borrowing for banks, encouraging them to pass on these savings to consumers and businesses through reduced lending rates. The CBK emphasized that banks will be monitored, and those that fail to adequately reduce lending rates will face penalties. This underscores the CBK’s commitment to ensuring that the benefits of the rate cut are transmitted throughout the economy. Private sector credit growth had contracted by 1.4% year-on-year in December, highlighting the need for increased lending.
Conclusion: A Proactive Stance for Economic Growth
The CBK’s decision to cut the benchmark interest rate and the cash reserve ratio signals a proactive approach to supporting economic growth in Kenya. By capitalizing on low inflation and a stable exchange rate, the CBK aims to stimulate private sector lending and investment, fostering a stronger economic recovery in 2025. The effectiveness of these measures will depend on the response of commercial banks and the overall global economic environment.
