Central Bank Cut its Policy Rate, but Why is the Yield Curve not Convinced?

Central Bank Cut its Policy Rate, but Why is the Yield Curve not Convinced?

The Central Bank of Kenya’s communication is an important policy instrument in shaping interest rate expectations. 

They not only guide long term bond yields through expectations of future short term interest rates but influences the premium on long term securities.

Thus far, signals from the central bank have been clear. 

Despite the debt sustainability concerns, interest rates should remain low. To this end, the monetary policy committee (MPC) cut the central bank rate (CBR) by 50bps to 8.50% last week. 

The tone of the statement suggested that the policy rate may be slashed further to support growth.

However, the market’s conviction of the rate cut is lacking. For good reason, signals are so far mixed.

Against a backdrop of a lower policy rate, the central bank continues to mop up excess liquidity at around 8.00% through 7-day term auction deposits (TADs). This is above the yield on the 91 day T-bill, currently trading at 7.162%, thereby distorting the yield curve.

At the same time, limited scope for fiscal consolidation may undermine the markets buy-in of the signal. A combination of weak revenue performance and persistent spending pressure may undermine efforts towards consolidation.

To this end, sustained upward pressure on TAD rates, may enhance pressure on T-bill yields by shifting liquidity towards the central bank. 

The resultant weak demand for government securities, across the curve, coupled with a higher than expected fiscal deficit (of around 6.30% of GDP) may still skew market expectations of higher interest rates.

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This could trump the intended impact of monetary easing and therefore result in a near-neutral response by the yield curve to the policy rate cut.


NCBA Research, NCBA Weekly Fixed Income Report – 02nd December 2019.