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The Monetary Policy Committee (MPC) is set to meet on Tuesday, 27^th November 2018, the last MPC meeting in 2018, to review the prevailing macro-economic conditions and make a decision on the direction of the Central Bank Rate (CBR). While noting the need to monitor the second-round inflationary effects arising from the VAT on petroleum products, and any perverse response to its previous decisions, the MPC maintained the CBR at 9.0% in their previous meeting held on 25^th September 2018. This was in line with our expectations as per our MPC Note, citing that the country’s macroeconomic fundamentals were stable as well as sustained optimism on the economic growth prospects, as evidenced by:

1. Inflation expectations, which were well anchored within the target range, having fell to 4.0% in August from 4.4% in July, following decreases in food prices that offset the increase in energy prices, including the increase in the price of charcoal. 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 August, with the highest growth in lending being recorded in the building and construction, manufacturing, consumer durables and trade sectors at 14.9%, 13.3%, 11.5% and 7.0% 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 rebound in agriculture, pick-up in private sector economic activity, strong forward hotel bookings, renewed business confidence due to the ongoing war against corruption, and a stable macroeconomic environment.

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, and,
2. The current account deficit had narrowed to 5.3% in the 12 months to July 2018 from 5.6% in June 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 and expected front-loading of imports with respect to the ongoing SGR project but the effects on the current account were expected to be mitigated by lower imports of food in 2018.

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

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. 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% with their decision being on the back of:

1. Despite expectations of inflationary pressure in the remainder of the year as the effects of the various tax policy measures introduced through the Finance Bill 2018 continue to be felt, we do not believe that the pressure is high enough to warrant a policy shift. Inflationary pressure has further been mitigated by the declining food prices due to the improved weather conditions and as such, inflation is expected to be within the government set target of 2.5%-7.5%,
2. Despite the recent depreciation of the Kenyan Shilling against the US dollar, it has remained relatively stable, reflecting a more stable economic environment, which saw the IMF reclassifying Kenya, from a floating arrangement to stabilized arrangement, in their Annual Report on Exchange Arrangements and Exchange Restrictions released on 30^th April 2018. The classification of the arrangement, is primarily based on the degree to which the exchange rate is determined by the market- rather than by official action. For a country to be classified as a stabilized arrangement, the market exchange rate should remain within a margin of 2.0% for 6 months or more with respect to a single currency or a basket of currencies, thus showing the stability of the Kenyan shilling. Volatility of the Kenyan shilling has however mainly been cushioned by central Bank’s activities, which has seen the forex reserves decline by 4.4% to USD 8.1 bn from USD 8.4 bn, since the last MPC meeting but still remain high and above the optimal level of reserves for Kenya as per the IMF set at 3.5 months of imports . The ongoing prospects of the Treasury issuing another Eurobond could also eliminate the need for tightening the monetary policy, as it will enhance the forex reserves thus cushioning the shilling.
3. Private sector credit growth has remained unchanged at 4.3% for the 3 months to September, since the lowering of the CBR to 9.0% in July, higher than the 3.3% average for the 9 months to September 2018 as well as the 2017 average of 2.5% but is still below the 5-year average of 12.6%