Short Term Rates Drop Below Central Bank Rate – Signal for More Accommodation?

The current surge in COVID-19 cases and inflation well anchored, the Central Bank of Kenya is likely to maintain the status quo on policy rates.

Dr Patrick Njoroge, CBK Governor.

Central banks across the world have shown greater tolerance to inflation since the outbreak of the Covid-19 pandemic. 

To be sure, despite record acceleration in prices in advanced economies, forward guidance from respective monetary authorities has continued to point towards prolonged ultra-easy monetary policies, as they view the current pressure as transitory.

Locally, inflation has stabilized in the 5.0-6.0% levels so far this year and is projected to remain within the statutory target band of 2.5-7.5%. 

While downside risks from higher oil prices and supply constraints could see price increases quicken, the scope may be limited by persistently subdued demand pressures. 

Like central banks in advanced economies, we expect the CBK to remain inclined towards more accommodation as risks to growth from the pandemic mount amid well-anchored inflation expectations.

That said, it is worth noting that short term rates have dropped significantly in recent weeks, some below the benchmark policy rate (CBR) currently at 7.0%. 

To be sure, the yield on the 91-day T-bill has declined to 6.860% and prospects for the 182 and 364-day yields, currently at 7.317% and 7.729% respectively, dropping to inches of 7.0% remains material.

Ideally, the central bank seeks to align short term rates to its policy rate for proper signalling. 

While the market hardly guides policy decision, it could be a precursor of future expectations on how interest rates should evolve. 

To this end, there is a fair chance that a further and prolonged decline in short term rates could give the regulator some comfort to move lower.

Yield curve to further steepen thanks to healthy external government flows 

The spread between short term and long term yields widened further in the week as the rally on the shorter end persisted. 

In the week, the three, six and twelve-month T-bills sold 14.0bps, 21.90bps and 37.60bps lower respectively.

Markets may remain price takers in the interim as the government continues to demonstrate a muted appetite for local debt. 

The government achieved its 2020/21 KES 521Bn local borrowing target with limited upside on yields. 

While earlier the scale of borrowing had ignited some pressure on yields, this was mostly neutralized in the sunset weeks of the fiscal cycle as a preference for external deficit financing increased.


NCBA Market Research