Kenya's central bank surprised financial markets by cutting its Central Bank Rate (CBR) by 50 basis points to 9.50 percent, saying there was scope to ease its monetary policy stance to boost economic activity as inflation expectations are well anchored and economic output is below its potential level.
It is the first rate cut by the Central Bank of Kenya (CBK) since September 2016 and the bank's monetary policy committee said it would closely monitor the impact of this cut along with changes to the global and domestic economy and "stands ready to take additional measures as necessary."
CBK said the meeting by its policy committee was held "against a backdrop of sustained macroeconomic stability, improved weather conditions, increased optimism on the economic growth prospects, improvement in the business environment, and the continued strengthening of the global economy."
Kenya's inflation rate has been decelerating steadily in the last 12 months and fell to 4.46 percent in February from 4.83 percent in January and a 2017-high of 11.7 percent last May.
A fall in food prices outweighed a rise in fuel prices from higher global oil prices and CBK said it expects inflation to remain within the government's target of 5.0 percent, plus/minus 2.5 percentage points, in the near term.
The committee's private sector market perception survey from this month showed inflation was expected to decline in the near term and growth expectations for 2018 were higher.
The exchange rate of Kenya's shilling has been firming this year on improved investor sentiment, supported by a narrower current account deficit, with the central bank expecting the deficit to narrow further to 5.4 percent of Gross Domestic Product this year from 6.4 percent in 2017.
The shilling was trading at 101.2 to the U.S. dollar today, up 1.9 percent since the start of 2018.
Strong growth in the export of tea and horticulture, continued income from tourism and workers abroad, has also boosted Keny's foreign exchange reserves to an all-time high of US$8.832 billion from $7.089 billion in January.
Together with the recently extended precautionary arrangement of $989.8 million from the International Monetary Fund, this will provide the country with additional buffers against shocks.
Last week the IMF approved Kenya's request for a 6-month extension of its stand-by arrangement so reviews can be completed by September, with the government committing to reduce its fiscal deficit and "substantially modifying interest controls."
In September 2016 Kenya's government imposed a cap on banks' interest rates, despite objections by the IMF and banks, arguing that lenders were not passing on low rates to borrowers.
But the cap of 4 percent above the CBK rate has essentially dented the pass-through effect of the central bank's policy decisions and private sector credit grew by only 2.1 percent in the 12 months to February, down from 2.4 percent in December.
However, CBK added lending to manufacturing, real estate and trade sectors remained relatively strong, up by 13.1 percent, 8.3 percent and 5.9 percent, respectively.
Kenya's economy has been slowing in recent quarters and expanded by only 0.4 percent in the third quarter from the second quarter for annual growth of 4.4 percent, down from 5.0percent.
But the CBK's survey showed "almost unanimous optimism" by the private sector about 2018 based on a stable economic environment, favorable weather, confidence, continued public investment in infrastructure, expected direct flights to the U.S. and political stability.
Uncertainties stem from U.S. trade policies, a resolution to the UK's trading relationship with the European Union and the pace of monetary policy normalization in advanced economies, CBK said.
