The Central Bank of Kenya (CBK) has announced a new monetary policy framework that aims to improve its ability to achieve its inflation target and support economic growth.
The new framework, which was approved by the Monetary Policy Committee (MPC) on July 27, 2021, introduces an interest rate corridor around the Central Bank Rate (CBR), which is the main policy rate, and lowers the cost of borrowing from the CBK’s Discount Window.
“Henceforth, the monetary policy operations will be aimed at ensuring the interbank rate, as an operating target, closely tracks the Central Bank Rate (CBR),” said Dr Kamau Thugge, the MPC Chairman.
The interest rate corridor is set at ± 250 basis points, meaning that the CBK will intervene in the interbank market to keep the interbank rate, which is the rate at which banks lend to each other, within a range of 2.5 percentage points above or below the CBR.
The CBK hopes that this will reduce volatility and uncertainty in the interbank market and ensure that changes in the CBR are transmitted more effectively to other interest rates, inflation, and economic activity.
The Discount Window is a facility that allows banks to borrow from the CBK in case of liquidity shortages.
“In addition, to improve access to the Discount Window, the Committee agreed to reduce the applicable interest rate from the current 600 basis points above CBR to 400 basis points above CBR.,” said Dr Kamau.
This is intended to improve access to liquidity and encourage banks to lend more to businesses and households.
The new framework is part of the reforms outlined in the White Paper on Modernization of the Monetary Policy Framework and Operations, which is a document that describes the vision and strategy of the MPC to adopt a forward-looking monetary policy based on inflation targeting.
Inflation targeting is a monetary policy strategy that involves setting an explicit inflation goal and adjusting the policy rate accordingly.
The CBK’s inflation target is 5 per cent with a margin of ±2.5 percentage points.
The White Paper also details other measures that the MPC will implement to strengthen its policy formulation tools, upgrade its implementation infrastructure, ensure effective communication, improve policy transmission and enhance financial system stability.
The former CBK Governor Dr. Patrick Njoroge said that the new framework will enable the MPC to “respond more effectively to emerging shocks” and “support sustainable economic recovery” amid the challenges posed by the COVID-19 pandemic.
He also said that the new framework will align Kenya’s monetary policy with international best practices and enhance its credibility and accountability.