Kenya's central bank raised its benchmark Central Bank Rate (CBR) by 150 basis points to 10.00 percent, saying the emerging pressures from demand and persistent volatility in foreign exchange markets along with an expected recovery in oil prices would affect inflationary expectations while the pass-through of past depreciation of the shilling would impact inflation.
It is the first change in interest rates by the Central Bank of Kenya (CBK) since May 2013 but the move was expected after the central bank brought forward its July policy meeting and warned in May that it would pursue a tightning bias in the money market to anchor inflation expectations.
Economists had expected the CBK to raise its rate today, though only by 50 or 100 basis points, underscoring the CBK's determination to send financial markets a message that it is committed to reduce inflation and avoid further depreciation of the shilling.
The shilling has been depreciating since early March and hitting lows not seen since 2011, when the shilling fell to 106 to the U.S. dollar, forcing the CBK to raise its rate to a record 18.0 percent.
In addition to the volatility in foreign exchange markets from the expected tightening of U.S. monetary policy, the shilling has been hit by falling foreign exchange flows as tourists have become unsettled by attacks in Kenya by Somalia's al Shabaab insurgents and a wider current account deficit.
The CBK said the exchange rate had stabilised in response to its operations that had led to tight interbank liquidity - the CBK has on several occasions intervened in foreign exchange markets - and the exchange rate had been supported by sustained foreign exchange inflows from diaspora remittances that averaged US$ 122.18 million a month in the first four months of this year compared with an average of $113.6 million in the same period in 2014.
The central bank said its usable level of foreign exchange reserves amounted to $6.739.2 billion, down from $6.859 billion at the end of April and $7.224 billion as of Feb. 26.
In response to the today's rate hike, the shilling firmed to 97.0 to the dollar from 97.7 yesterday, but is still down 6.6 percent this year and 10.8 percent since the start of 2014.
In May Kenya's consumer price inflation rate eased to 6.87 percent from 7.08 percent in April, but the CBK said this was largely a reflection of significant decreases in the prices of a number of for items following the onset of the long rains.
"However, overall inflation remained within the upper bound of the Government target range of 2.5 percent on either side of the medium-term target of 5 percent," the CBK said in a statement signed by Haron Sirima, acting CBK governor.
Kenya's president has nominated Patrick Ngugi Njoroge, an adviser to the International Monetary Fund, to succeed Njuguna Ndung'u as governor after he completed his term in March.
"Growth is expected to remain resilient in 2015 supported mainly by private sector credit growth to key sectors of the economy, prudent macroeconomic policy and sustained public investment in infrastructure," the CBK said.
On June 4 the IMF also said Kenya's economy remained "resilient" and projected growth this year of around 6.5 percent and gross international reserves of $7.3 billion as of end-May were adequate.