The Monetary Policy Committee met on Wednesday 14th of September to discuss the current market volatility. The outcome was an increase in the Central Bank Rate (CBR) of 75 bp to 7.0% from 6.25%. This was done so as to ward off further inflationary pressures. The current inflation rate is at 16.67% against a target of 5%. In addition, underlying inflation (inflation less food and energy inflation) is currently at 7%. The spread of 200 bp (Underlying inflation less inflation target) is a cause of concern for the MPC.

Further to this, the IMF's Extended Credit Facility is conditional upon a change in the composition of the broad money supply. Both M3 and L, with a bias towards Net Foreign Assets. Therefore the CBK, through policy actions should reduce the amount of domestic assets (NDA, in a nutshell shilling denominated assets) and increase the amount of foreign assets (assets denominated in foreign currency). This is being done with a view of shielding the economy from the adverse effects of our poor trade balance. Imports by far exceed exports, in addition our terms of trade are deteriorating. Simply, we are buying more than we sell and in addition the our buying prices by far exceed our selling prices.

To this end, I expect the shilling to further weaken. I think the shilling could hit the 100 mark by year end, although the Infrastructure bond could attract diaspora inflows. I then expect interest rates to rise in the mid-term as the tightening has an effect on money market liquidity. The current spike in T-bills to 12.57% is a pointer towards this.

Those who think that the MPC decision was good, suffer from delusion and probably an existentialist crisis. The famous philosopher Rene Descartes said "I think and therefore I am"... it follows that if you cant think then you don't exist.

If you raise rates and tighten liquidity due to cost-push inflation, you are seriously endangering economic growth. Furhermore, once T-bill and T-bond rates sky-rocket, there will be a serious re-alignment of domestic credit as banks lend more to the government and less to clients. We could see a serious slow-down in the private sector's access to credit going forward.

Note that the decision wasn't motivated by the CBK, but rather the IMF so don't blame Prof. Ndung'u.