Central Bank study finds CBR rise hurts economic

Money Markets

The Central Bank of Kenya. An increase in the Central Bank of Kenya (CBK) policy benchmark causes the economy to slow down significantly, a new study by the regulator says. FILE PHOTO |  NATION MEDIA GROUP

By GEOFFREY IRUNGU, girungu@ke.nationmedia.com

Posted  Wednesday, October 29  2014 at  19:29

In Summary

• The research, titled Monetary Policy Transmission Mechanism in Kenya, says the monetary authorities walk a tight rope between addressing inflation and economic growth.

An increase in the Central Bank of Kenya (CBK) policy benchmark causes the economy to slow down significantly, a new study by the regulator says.

This finding may be the main reason CBK has been reluctant to raise the policy rate even as some analysts recommended tightening to reduce inflationary expectations.

“Thirty basis points (0.3 percentage points) of monetary policy tightening also penalises the economy to the extent of 0.6 basis points of reduced real output,” says the study.

The research, titled Monetary Policy Transmission Mechanism in Kenya, says the monetary authorities walk a tight rope between addressing inflation and economic growth.

“In other words, for 30 basis points of monetary policy tightening using the policy rate we would on average… achieve one basis point reduction in the headline Consumer Price Index,” said the study.

The research was conducted by two economists, Benjamin Maturu and Lydia Ndirangu, and was published by the CBK as a working paper, meaning that contributions to its refinement are still welcome.

With the CBR at 8.50 per cent for 18 months now, some analysts have speculated the risk of tightening has risen in view of a weakening currency and impact on inflation, which in August exceeded the upper limit of 7.50 per cent before falling to 6.6 per cent.

READ: CBK retains signal rate amidst rising inflation

Policy tightening

“The weaker Kenya shilling increases the risk of policy tightening before year-end,” said Razia Khan, head of research on Africa at StanChart, in a statement in August.

Earlier in the year, Ms Khan pointed out that economic growth was a major concern for CBK as it considered whether to tighten or not. But she also noted the “authorities’ perceived reluctance to tighten”.

However, with the onset of the short rains and falling energy prices CBK might find it less compelling to tinker with CBR.

The study by Mr Maturu and Ms Ndirangu noted the importance of keeping expectations of low inflation as there was a tendency for headline inflation to entrench itself over a long period.

“These results imply that there has been substantial inertia in the headline CPI inflation with further implication that once headline inflation sets in, it tends to entrench itself over a long period of time,” the two economists wrote.

The study concluded that the CBR was a fairly effective a tool of monetary policy, but that it often took some time before expected changes – such as interest rates – were seen.