- The US Fed rate has risen in the past one year to January 2024 by about 17% leading to a much stronger dollar that is pilling pressure on the weakening shilling.
- The local currency has shed about 35 units of its value year-to-date to trade at 158.87 on Tuesday.
Pressure on the Kenyan shilling could persist this year, further eroding its value against major currencies into the third quarter of 2024.
The International Monetary Fund (IMF’s) latest interest rates forecast update for major economies between 2024-2028, projects the rates to peak at the start of 2024, after they continued to climb at a slower pace last year.
“The U.S Federal Reserve, for example, is expected to see interest rates peak around 5.4 per cent before beginning to implement rate cuts in Q3,” the lender says.
“Since 2022, interest rates have climbed in the European Union, United Kingdom and the United States by at least four percentage points.”
IMF’s projection of a not so soon respite in the already high U.S Fed rate means the trend of the shilling depreciation in value could be here for much longer, pointing towards a continued increase in the cost of living, although slightly lower than the highs of 2020-21.
Federal funds rate is the rate banks charge each other for lending their excess reserves or cash, and it is a target rate set by the Federal Reserve Bank, used as a basis for the rate that commercial banks adopt while lending to each other.
However, the fed funds rate has a far more sweeping impact on the economy as a whole. The fed funds rate is a key tenet of interest rate markets and is used to set the prime rate, which is the rate banks charge their clients for loans.
Also, mortgage and loan rates, as well as deposit rates for savings, are impacted by any changes in the fed funds rate.
Changes in the federal funds rate can impact the U.S. dollar. Its increase typically increases interest rates throughout the economy.
The higher yields then attract investment capital from investors abroad, seeking higher returns on bods and interest-rate products.
The ripple effects then prompts global investors to sell their investments denominated in their local currencies, for instance in Kenyan shillings in exchange for U.S. dollar-denominated investments.
The final result is a stronger exchange rate in favour of the U.S. dollar, which then strengthens against the local currencies. in this case, the shilling.
The US Fed rate has risen in the past one year to January 2024 by about 17 per cent, leading to a much stronger dollar that is pilling pressure on the weakening shilling that has shed about 35 units of its value year-to-date to trade at 158.87 on Tuesday.
Since it started weakening in early 2020, the shilling has lost about 58 per cent of its value against the greenback, a trend that hit importers in the country with increased importation costs.
This burden is often passed to the consumers, prompting an increase in the general cost of living.
With the country being a net importer, this means importers are now incurring an extra Sh58 to buy a dollar for imports, as compared to early 2020.
A weak shilling is also expected to pile pressure on the country’s forex reserves as importers seek the much-needed dollar to pay for imports.
Usable reserves are currently at $6.8 billion (Sh1.07 trillion) compared to $7.4 billion (1.17 trillion) same period last year, 3.6 months of import cover, below the desired minimum of at least 4 months.
Petroleum products are among Kenya’s key imports and stand to be affected by a weak shilling, with high prices having multiplier effects in the transport sector, farm production and manufacturing.
Others are fertiliser, edible oil, steel and clinker among others, with an assortment of raw material importers by local factories also costing more on a weaker shilling.
Kenya's external debt burden is also expected to grow on a weak shilling, as majority of it is dollar denominated.