The Central Bank of Kenya (CBK) cut its Central Bank Rate by 150 basis points to 9.50 percent, slightly more than the 100 basis points expected by economists, with the bank saying this reduction should increase the uptake of credit by the private sector and help re-align commercial interest rates.
The CBK said the economic outlook was positive with stable inflation and foreign exchange rates, and the main risk to macroeconomic stability was a full resolution of the euro zone's problems along with its high current account deficit.
Last month the central bank had said slow global growth, volatile oil prices and the high current account deficit were the main risks.
Kenya's economy is recovering from the CBK's aggressive rate hike campaign to combat inflation from 2011 until mid-2012 when the bank reversed course and started cutting rates. Last year it cut by a total of 700 basis points but commercial lending rates still remain above 19 percent.
In December, Kenya's inflation rate eased for the 13th month in a row to 3.2 percent, down from 3.25 percent in November and a new low for the year.
The bank said the drop reflected a continued fall in food prices and easing demand pressures with non-food and non-fuel inflation down to 4.81 percent from 4.83 percent so both inflation measures were now below the government's 5 percent medium term target.
"These developments, coupled with improved weather conditions and declining international oil prices continue to support a low and stable short-term outlook for inflation," the CBK said in a statement following a meeting of its monetary policy committee.
Kenya's economy continued to strengthen in the third quarter and confidence remains high, the bank said, with Gross Domestic Product expanding by an annual rate of 4.7 percent, up from 3.3 percent in the second quarter.
The bank's survey in December showed that the private sector expects inflation and exchange rates to remain stable this year and "increased optimism for a strong recovery in growth in 2013."
The CBK's monetary easing had improved liquidity and stability in the interbank market and the downward trend in private sector credit growth has reversed, the bank said, with growth up to 9.07 percent in November from 7.12 percent in October.
It also said that commercial banks' lending rates had come down slightly and the number of loan applications had risen by 32.5 percent in November from October.