Bankers are pushing the Central Bank of Kenya to increase the benchmark lending rate during tomorrow’s review, warning that current higher pump prices could reignite inflation pressures in the country effectively destabilising a fragile economy.

In a research paper published ahead of the CBK's Monetary Policy Committee meeting set for 9th June, the Kenya Bankers Association (KBA) noted that a "timely upward adjustment" of key lending rate is critical in stemming inflation while also protecting the country against second-round impacts of increasing energy costs.

Kenya's headline inflation rose sharply to 6.7 percent in May, increasing from 4.4 percent in April according to the Kenya National Bureau of Statistics largely on account of steady jump in pump prices which drove up transport bills,

Fuel-induced inflation increased to 16 percent in May, KNBS data showed, up from a lower 13.4 percent in April and 10.8 percent in March, even as the war in the Middle East continues, leaving policymakers on edge as global energy markets swing in turmoil.

While core inflation remains relatively contained at an average of 2.5 percent over the past six months, bankers warned that higher production and distribution costs are rapidly feeding into broader increase in prices across industries.

“The pass-through effect of the increase in global oil prices has translated into sharp increases in domestic petrol and diesel costs,” KBA research paper explains. “Fuel prices alone are expected to exert a significant upward push to headline inflation through second-round effects.”

Economy shows signs of weakening

KBA's call for tighter fiscal policy comes even as Kenya’s economic growth continues to show signs of weakening amid global turmoil. 

According to the latest survey on private sector business activity, May's Purchasing Managers’ Index (PMI) remained below the 50.0 contraction mark for the third consecutive month, standing at 46.6. 

Across key industries, the increase in fuel and input costs have driven up operational bills, dampening customer demand and slashing the volume of new orders. KBA notes that cost-driven demand suppression is becoming increasingly visible across the economy.

This places the MPC in a difficult position as they meet on June 9th: raising the key lending rate would help counter the pace of change in inflation but it equally risks further choking off growth. The bankers, however, argue that the balance of risks has shifted decisively toward inflation.

Credit growth, while recovering, remains fragile. Private sector credit expanded by 8.10 percent in March, supported by a reduction in lending rates to 14.7 percent following the CBK’s earlier easing. 

But the KBA cautions that emerging uncertainty over the future path of interest rates and rising credit risk, attributable to inflationary pressures, are weighing on household and business appetite for new loans. 

The stock of non-performing loans in the country remain elevated at 15.6 percent of gross loans, and a further buildup in inflation could worsen asset quality in the banking industry, effectively discouraging banks from extending new credit.

However, the Kenyan shilling has been a rare bright spot, trading relatively stable at around Kes 129.45 per US dollar, supported by robust official foreign exchange reserves of $13.2 billion—equivalent to 5.6 months of import cover, well above the statutory four-month threshold. Inflows from tourism and diaspora remittances have also provided a buffer.

KBA warns that the external position is facing headwinds. The current account deficit is expected to widen from 1.8 percent to 2.1 per cent as the oil price shock inflates the import bill for fuel and related products. This could put renewed pressure on the shilling in the medium term.

Globally, major central banks, including the US Federal Reserve and the European Central Bank, kept policy rates unchanged in April, mirroring the CBK’s decision to hold the CBR at 8.75 percent at its last meeting.

“We opine that a timely upward adjustment of the Central Bank Rate will effectively anchor inflation expectations and support price stability in the medium term,” the note concludes.

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