Kamau Thugge strikes, sets tone with highest loan rate in seven years

Nominee for the governor of the Central Bank of Kenya Dr Kamau Thugge before the Departmental Committee on Finance and National Planning at County Hall for vetting on May 30, 2023. PHOTO | DENNIS ONSONGO | NMG  

By KEPHA MUIRURI More by this Author

After just one week in office, the new Central Bank of Kenya (CBK) Governor Kamau Thugge called a surprise policy-making meeting on Monday that increased the

benchmark lending rate to the highest point in nearly seven years on heightened fear of a spike in consumer prices.

The move, which sets the tone of the new CBK leadership, has ushered in a new era of expensive bank loans and will further erode the spending power of Kenyan consumers.

Higher interest rates mean consumers will spend more to service their loans. Besides bank borrowers, the higher rates will also hit ordinary consumers in the form of more expensive goods on the shelves.

The government, which is expected to tap the majority of its debt financing for the new financial year from the domestic market, will also not be spared.

The regulator lifted the Central Bank Rate by one percentage point at the surprise Monetary Policy Committee (MPC) meeting on Monday to 10.5 percent from 9.5 percent, setting the benchmark lending rate at the highest level since July of 2016 or an 82-month high.

The rate of increase was also the highest in nearly eight years since July of 2015 when the CBR rose by 150 basis points (1.5 percent).

“This is a forward-looking rate hike, with the CBK looking to contain the effects of the 16 percent VAT on fuel and the impact of other taxes from the Finance Act 2023. The CBK is seeking to keep a handle on inflation,” Wesley Manambo, a research analyst at Genghis Capital, told the Business Daily.

While lifting the benchmark interest rate, the MPC cited sustained pressure on inflation and observed risks for higher consumer prices which in its view would have a negative impact on the economy.

“Overall inflation is expected to remain elevated in the near term, mainly due to the recent increase in electricity prices, the removal of the fuel subsidy, and associated second-round effects. Additionally, a mini-survey of the agriculture sector in the first half of June revealed that prices of some key food items, particularly sugar and maize remain, elevated,” the CBK said in a statement.

The higher reset of the benchmark interest rate, which seeks to trim demand for goods and services in the economy by limiting money in supply, comes barely a month since the CBK, under the previous leadership of Dr Patrick Njoroge, left interest rates unchanged on improved inflation expectations.

Read: Shilling breaches 140 to dollar as new CBK boss takes charge

The CBK has since seen a change of guard, with Dr Thugge taking over as the new Governor of the apex bank on June 19.

On May 29, the MPC opted to leave interest rates unchanged, assessing inflation pressures at the time as mild while expecting improved rainfall this year to cushion food prices, which have the largest effect on inflation.

“Food inflation is expected to moderate in the coming months following the long rains, and lower global food prices. Nevertheless, the recent increases in electricity prices, the removal of the fuel subsidy, and a sharp rise in sugar prices are expected to exert moderate pressure on overall inflation,” the CBK stated at the time.

Externally, the CBK notes the global economic outlook remains uncertain, reflecting continued concerns about the financial sector stability in advanced economies, continued geo-political tensions and an extension of monetary policy tightening increasing of interest rates by central banks in advanced economies.

The surprise rate hike by the CBK comes against the backdrop of Monday’s assent of the 2023 Finance Bill by President William Ruto, clearing the way for implementation of the new taxes that take effect from July 1.

The tax proposals are widely expected to exert more pressure on inflation, with the doubling of VAT on petroleum products for instance lifting the cost of fuel by upwards of Sh10 per litre from Saturday this week.

The doubling of the rate of VAT on petroleum products alone is expected to have a compounding effect on not just the cost of transportation but also the prices of food and electricity.

This is set to send the rate of inflation beyond the printed 8.0 percent in May, from a slightly lower 7.9 percent in April.

Inflation has stubbornly remained above the government’s sweet spot of 2.5 to 7.5 percent since June last year, primarily from higher food prices on lower productivity from depressed rainfall over the past two planting seasons.

While higher lending rates may achieve the target of dampening demand and extinguishing inflation’s second-round effects, rising interest rates will leave a bitter taste in the mouth of borrowers who will see their monthly loan payments rise in tandem with the benchmark lending rate.

Already, the cost of borrowing is at the highest level since July 2018, with the average commercial lending rate standing at 13.1 percent as of April, according to secondary CBK data.

The rising cost of borrowing is expected to start chipping away at private sector credit growth, which has so far shown resilience, holding at 13.2 percent in both April and May on sustained demand for credit particularly by businesses that have highlighted working capital requirements.

According to the CBK, strong credit growth has been observed in the manufacturing, trade, real estate and transport and communication sectors.

“The number of loan applications and approvals remained strong, reflecting increased demand and resilient economic activities,” the CBK added.

On its part, the government is expected to face increased pressure to pay out a higher risk-adjusted return as investors price in the higher benchmark lending rate and the impact of sustained inflation to the real return -- the effective yield on an investment after factoring in inflation.

Yields on the short-dated Treasury bills are already on their way to hitting 12 percent, with the return on the 364-day paper, for instance, having peaked at 11.934 percent last week, rising from 11.734 percent a week earlier.

Read: CBK signals costly loans after hiking rates to five-year high

Previously, the CBK stated higher interest rates on borrowers would be the opportunity cost for keep inflation down. Then CBK Governor, Dr Njoroge, said a high cost of living would have far-reaching consequences over the medium to long term than the effect of costlier loans.

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