Kenya's central bank on Tuesday raised the benchmark lending rate from 10 percent to 11.5 percent to check inflation, tighten liquidity and take pre-emptive steps to strengthen the local currency.
The Central Bank of Kenya (CBK)'s Monetary Policy Committee (MPC), which met Tuesday in Nairobi to review the market's reaction to its benchmark rate, also revised the loan-pricing formula known as the Kenya Banks Reference Rate (KBRR) from 8.54 percent to 9.87 percent.
"The Committee noted elevated risks to the inflation outlook mainly attributed to pressures on the exchange rate over the last few months," CBK Governor Patrick Njoroge said in a statement.
Analysts said CBK's decision to adjust upwards the Central Bank Rate (CBR), which sets the tone for interest rates charged by banks, to 11.5 percent could see an upward rise in the cost of loans and other financial products in the short-term.
Njoroge said MPC decided to augment its instruments for liquidity management by introducing a three-day repurchase agreements (Repos). The agreements are offering higher returns at above 10 percent.
The committee noted the need to closely monitor liquidity conditions in the market, and promised to continue monitoring external and domestic developments as well as their implications on the risks to the overall price stability.
Kenya's month-on-month overall inflation increased to 7 percent in June from 6.9 percent in May, mainly reflecting increases in fuel prices, pass-through effects from the weakening Kenya shilling against the U.S. dollar and moderate demand pressures in the economy.
Njoroge, who is also MPC chairman, said the local currency has remained under pressure, mainly reflecting the strengthening of the U.S. dollar against most currencies.
"The increased budgetary allocations towards bolstering security and facilitating the recovery of the tourism sector will support the long-term stability of the exchange rate," he said.
The CBK governor said the current account deficit widened in part due to increased imports of capital equipment and weak exports. However, diaspora remittances remain resilient.
The CBK's level of usable foreign reserves, Njoroge said, remain adequate at 6.63 billion dollars (equivalent to 4.2 months of import cover). Njoroge said his bank and policymakers at the Treasury are seeking a mixture of good policies and the best of intentions to strike a policy balance on the exchange rate and the CBR consistent with the demands of the local economy.
The latest data from the Kenya National Bureau of Statistics showed that the economy remained robust in the first quarter of 2015. Growth improved to 4.9 percent in the first quarter of 2015, compared with a growth of 4.7 percent in similar period of 2014.