The Monetary Policy Committee (MPC) is set to meet on Tuesday, 25^th September, 2018 to review the prevailing macro-economic conditions and make a decision on the direction of the Central Bank Rate (CBR). While noting the risk of perverse outcomes, the MPC lowered the CBR by 50 bps to 9.0% from 9.5% in their previous meeting held on 30^th July 2018,  which was not in line with our expectations as per our MPC Note, citing that economic output was still below its potential despite improving economic growth prospects, as evidenced by:

1. Inflation expectations which were well anchored within the target range despite rising to 4.3% in June from 4.0% in May. The MPC noted that the overall inflation was expected to remain within the government target range of 2.5%-7.5% despite upward pressure from rising fuel prices due to a rise in global oil prices and the impact of excise duty on some of the CPI items. Expectations of declining food prices due to favorable weather conditions was expected to mitigate the upward inflationary pressure,
2. Private sector credit growth, which grew by 4.3% y/y in June up from 2.8% in April, with the highest growth in lending being recorded in the building and construction, manufacturing, and trade sectors at 13.5%, 12.3% and 8.6% over the same period, respectively, and,
3. Increased private sector optimism as per the MPC Private Sector Market Perception Survey conducted in May 2018, which indicated that the private sector was optimistic about local economic prospects in 2018. This was mainly attributed to a relatively stable macroeconomic environment, renewed business confidence, a rebound in agriculture due to improved weather conditions, continued infrastructure investment by the government, with the government’s focus on the Big Four Agenda.

The decision to lower the CBR was not in line with our expectation which was to maintain the rate at 9.5%. We believed that the MPC would adopt a wait and see approach as they monitor the effects of the previous rate cut given the stability in the macroeconomic environment, as had been evidenced by

1. Inflation which had averaged 4.2% in the first 6 months of 2018 compared to 9.8% experienced in a similar period in 2017. We expected inflation to rise in H2’2018, but the overall average inflation for the year to remain within the government target of 2.5%-7.5%, thus no need to tighten monetary policy which is used to restrict liquidity to slow down inflation, as there were no expectations of high inflationary pressure,
2. The government was not expected to be under pressure to borrow given the decline in the borrowing requirement to plug in the FY’2018/2019 budget to Kshs 558.9 bn from Kshs 620.8 bn in the FY’2017/2018 budget, with domestic borrowing estimated at Kshs 271.9 bn, 8.6% lower than the 2017/2018 fiscal year’s target of Kshs 297.6 bn, and,
3. The currency had appreciated by 0.4% since their last meeting on 30^th July, 2018. We also reasoned that maintaining the CBR would be a better move given the low private sector credit growth despite having improved to 2.8% in April from 2.0% in March; lowering the CBR would further limit credit access to the private sector, which was still a key concern as it was still below the 5-year average of 14.0% as well as the government set annual target of 12.0% – 15.0%.

The monetary policy committee also noted that

1. The overall inflation was expected to remain within the government target range mitigated by the decline in food prices following improved weather conditions despite expectations of upward pressure from rising fuel prices driven by the increase in international oil prices, and the impact of the excise duty indexation on prices of some of the CPI items,
2. The current account deficit had narrowed to 5.8% in the 12 months to June 2018 from 6.3% in March 2018 and was expected to narrow further to 5.4% of GDP in 2018 supported by strong growth of agricultural exports particularly tea and horticulture, improved diaspora remittances, and tourism receipts. The petroleum products import bill was however expected to increase due to higher international oil prices but the effects on the current account were expected to be mitigated by lower imports of food and SGR-related equipment in 2018.

Below, we analyse the macro-economic indicators trend since the July 2018 MPC meeting, and how they are likely to affect the MPC decision on the direction of the CBR:

<tdclass="hold" width="70">Neutral

Conclusion

Of the six factors that we track, one is negative, two are neutral, and three are positive, with no change since the last MPC meeting. With inflation having eased to 4.0% from 4.4% since the last meeting despite the currency having depreciated by 0.5% mainly driven by increased dollar demand as the country edged closer to the expiry of the IMF standby precautionary facility, we believe that the MPC should adopt a wait and see approach, given the macro-economic environment is relatively stable. We therefore expect the MPC to hold the CBR at 9.0%. The key concerns still remain

1. The low private sector credit growth, despite having improved to 4.3% in June, being the highest since December 2016, but still remains well below the 5-year average of 13.0% and the government set annual target of 8.8%, which is expected to slow economic growth.
2. The country’s fiscal deficit, which the government aims at reducing to 5.7% of GDP from 6.8% in FY’2017/2018 as per the fiscal consolidation agenda in the FY’2018/2019 budget with the 17.5% targeted increment in revenue collections to Kshs 1.9 tn through various tax policy measures, at the core of this agenda.

Currently there are uncertainties due to the ongoing stalemate with the Finance Bill 2018, which has brought concerns in the effective transmission of monetary policy considering the current interest rate environment, with the proposal by the National Assembly, to retain the interest rate cap, only scrapping off the floor rate on deposits which had been pegged on the Central Bank Rate(CBR). The Finance Bill has also threatened to frustrate the government’s efforts of raising additional tax revenues. With this, coupled with expectations of inflation remaining within the government set target of 2.5%-7.5% during the year despite inflationary pressures in H2’2018, we expect the MPC to retain the CBR at 9.0% which will also effectively maintain the current low lending rates to the government.