Kenya's unexpected rate cut on Wednesday will strengthen its economic recovery, stabilise bond yields and unleash a bull run in the stock market -- but not until the adoption of a new constitution is safely negotiated, according to Reuters. The central bank's Monetary Policy Committee on Wednesday confounded market expectations by cutting the bank's lending rate (CBR) by 75 basis points to 6 percent, the seventh cut since the start of an easing cycle in December 2008. It said it wanted to send a strong message to commercial banks to lower their stubbornly high lending rates and soothe market fears that yields across the curve were set to tick up after a largely domestic-driven bond market rally this year. "This shows a commitment from the central bank that it will keep rates low. The governor has been consistent that for as long as the recovery is slow he will keep rates low," said Duncan Kimani, head of fixed income at Bank of Africa Kenya. Bond traders expect overnight rates, which have hovered around 1.2-1.4 percent, will fall lower, providing room for yields on short-term government paper to drop lower still. Analysts said they expected yields on long-dated Kenyan paper to decline further in the short term as traders profited from low cash rates to snare higher yields further out. "What we'll end up seeing is a narrowing of the spread between the short and the long end, so that we move away from the 8 percent spread between the overnight and the long end of the curve, more to within a 4-5 percent spread," said Brian Muigai, treasurer at Equatorial Commercial Bank. The yield on the 5-year benchmark bond was down 40 basis points at 4.23 percent at 1100 GMT, with the 10-year yield down 40 basis points at 5.75 percent and the 15-year down 54 basis points at 6.11 percent, according to bid yields quoted by Standard Chartered on Reuters. SHOCK TACTICS Yields on 91- and 182- day Treasury bills have tumbled below 2 percent this year but the bank's commercial lending rates have remained stuck above 14 percent despite persistent calls from the central bank for its signal rate to be followed. "The central bank governor has cajoled and encouraged them and now he is using shock. I suspect they have got to fall into line pretty quickly," said independent analyst Aly Khan Satchu. Some analysts say that a traditionally conservative banking sector has been reluctant to cut its rates in light of a long history of high credit risk in east Africa's largest economy and a belief the lower yield curve was not sustainable. Muigai said he expected a move to more corporate lending by banks, but not until later this year and early next year. For now, however, it is next week's referendum on a new constitution that is influencing market behaviour. A new charter was central to a power-sharing agreement that ended weeks of tribal bloodletting after a disputed election in December 2007. It is seen as key to reducing the perceived risks of investing in Kenya. Opinion polls point to the vote being passed. Currency traders say the Kenya shilling is poised to fall through the 80.00 level against the dollar should the proposed referendum be endorsed in the Aug. 4 poll. "I don't see this checking the expected appreciation. What is expected is for banks to match (the rate cut) by lowering their rates and lending to the private sector," said Peter Mutuku, a trader at Bank of Africa Kenya. Razia Khan, head of Africa research at Standard Chartered Bank, said the hefty rate cut was not necessarily a negative factor for the currency for a number of reasons. On the one hand, the recent strengthening of the euro had increased the level of investor' risk appetite and emerging market currencies were benefitting again from the return. The bond market rally this year has been largely driven by domestic buyers rather than yield-seeking flows and to the extent further gains are seen, that could attract outside interest which would be positive for the shilling. The rate cut is also perceived to be positive for the economic recovery and if the stock market builds on its already hefty gains this year, it could also attract foreign buyers. "The CBK rate cut is not actually going to mean the Kenya shilling weakens," said Razia Khan, head of Africa research at Standard Chartered Bank. "There's certainly evidence that we are seeing the beginnings of that growth upswing." Analysts say Nairobi's stock market, hit hard after the 2008 post election violence, global downturn and drought stunted economic growth in 2008-2009, is poised to build on 37 percent year-to-date gains in the NSE 20 index if the constitution passes and there is no sustained violence. "For the equity market you then have those magical ingredients for the next bull move. I think most local institutions are overweight bonds and underweight equities so this might well be the shock to tip them into equities," Satchu said. "I am estimating the All Share Index is worth another 30 percent up to the year's end."
