Zambia's central bank left its policy rate steady at 15.5 percent, saying inflation is expected to decelerate sharply from the third quarter onwards as the impact of past monetary policy tightening and measures to reduce volatility in the exchange rate of the kwacha are starting to take effect.
The Bank of Zambia, which raised its rate by 300 basis points in 2015 and 275 points in 2014, forecast that inflation will continue to rise in the first quarter of this year and average 21.6 percent in the first quarter - inflation hit 21.8 percent in January - but then return to average levels seen between January and September 2015 following the second quarter of 2016.
Zambia's inflation rate was 7.7 percent in January 2015 and then 7.7 percent in September before it rocketed in October to 14.3 percent in response to the depreciation of the kwacha, high food prices, an increase in electricity tariffs, and high production costs induced by power rationing.
In response, the central bank raised its rate by 300 basis points in October last year to anchor inflation expectations and restricted banks access to liquidity. As a result, the overnight interbank rate exceeded the central bank's rate corridor of plus/minus 2 percentage points around the policy rate for much of that quarter and liquidity is expected to remain tight in the first quarter of this year.
Domestic credit contracted by 5.2 percent in the fourth quarter to K47.7 billion compared with an increase of 13.4 percent in the third quarter and foreign currency denominated credit fell by 11.7 percent to K9.6 billion as firms substituted foreign currency loans for kwacha loans to mitigate the rising currency risk from the volatility in the kwacha's exchange rate.
Zambia is Africa's second largest copper producer and prices have fallen in response to China's slowdown. This has hit the kwacha, which tumbled from August 2015 to Nov. 10 when it's exchange rate fell to 13.9 to the U.S. dollar from 6.4 at the start of the year, for a fall of 51 percent.
But the central bank then began intervening in the market to support the kwacha, helping it to bounce back to end the year around 11 to the dollar, a net depreciation of 42 percent.
"In light of reduced foreign exchange supply, particularly from the mining sector, that paused a risk to the smooth functioning of the market, the Bank of Zambia provided support to the foreign exchange market, amounting to US$294 million, " the bank said today.
Although high food prices and other supply side shocks play a significant role in boosting inflation, the Bank of Zambia said these shocks are better addressed through a combination of measures, including structural and fiscal policies.
Economic activity in Zambia "remained constrained" in the fourth quarter of last year, the bank said, estimating 2015 Gross Domestic Product growth of 3.6 percent, down from 4.9 percent in 2014.
Lower activity was mainly due to a decline in agricultural output from adverse weather and the rationing of power, which affected other key sectors. The rise in fuel prices and the sharp depreciation of the kwacha also raised production, transportation and other input costs, the central bank said.