Kenya monetary policy on ‘knife’s edge’

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Kenya’s surprise interest rate increase in March stabilised its weak currency but the central bank faces a dilemma between fighting inflation and supporting the economy, the bank’s governor said.

The rise in interest rates by 25 basis points to 6% followed only two months after the bank cut its benchmark rate.

Rising inflation, driven by short-term food price increases and rising fuel costs prompted the move, Kenyan Central Bank governor Njuguna Ndung’u said in an interview on the sidelines of the Institutional Investor Africa Investment conference.

“It is a knife’s edge, a serious knife’s edge. How do we balance inflation versus negative shocks?” said Ndung’u on Monday. “A country like ours is driven by negative shocks. We need a combination, or package of policies.”

Oil prices may have fallen from 32-month highs on Monday, but they remain well above normal. That is having a negative impact on the East African nation which is a regional financial hub.

Kenyan inflation in March rose to 9,19% from 6,54% a month earlier, raising market speculation the central bank may tighten rates further. Ndung’u declined to comment when asked about the bank’s policy bias.

“At 6% we have made the first step in managing the shocks of domestic inflation and a creeping currency rate.” he said.

“The bias for us is economic recovery. Whatever produces strong growth, we will go for it. We want to get back to a trajectory of 10% gross domestic product.”

The Kenyan government hopes to create 10% economic growth, per annum, for the next 20-25 years.

A series of seven interest rate cuts, the last of them in January, underpinned growth estimated at 5,4% in 2010. Inflation declined to a low of 3,09% in October and government bond yields also fell.

The expectation is coming rains will help increase food production and help alleviate inflationary pressures, Ndung’u said, adding that the bank was comfortable with economic growth in the 5,5-6% range for 2011.

The Kenyan shilling weakened to a lifetime low of 86,70/80 against the dollar on March 15 after the central bank said it would not intervene to defend the currency from the activity of speculators.

The shilling has snapped back in jagged fashion, trading at 84,10 on Monday.

The shilling’s steep fall came partly on worries oil prices would hit the roof on the crisis in North Africa and the Middle East. Rising fuel prices are partly to blame for increased demand from local oil importers who need to sell shillings and buy dollars.