Inside CBK's tough balancing act on loan costs

The Central Bank of Kenya (CBK) faces a high-stakes decision on interest rates on Tuesday, caught between a cooling economy, a massive government borrowing plan, and mounting political pressure to deliver affordable credit ahead of next year's General Elections.

This will be the first Monetary Policy Committee (MPC) meeting of this year since it cut the Central Bank Rate (CBR) by 25 basis points to 9.00 per cent in December 2025. 

At that meeting, the committee cited easing inflation, resilient economic growth, and an improving credit environment as reasons for the cut, which was intended to "stimulate lending by banks to the private sector and support economic activity."

The MPC will now reconvene as President William Ruto enters the home stretch of his first term.

His campaign pledge to provide cheap "hustler" credit to millions of small businesses and people remains largely unfulfilled after a protracted period of high interest rates, despite the recent policy easing.

“The next MPC meeting will be held on Tuesday, February 10, 2026,” said CBK.

While inflation fell further to 4.4 per cent in January 2026, from 4.5 per cent in December—firmly within the government’s 2.5 per cent to 7.5 per cent target band—economists say the CBK's room to manoeuvre is now constrained by a looming fiscal deficit.

A key industry lobby has weighed in ahead of the meeting, urging caution. In a research note, the Kenya Bankers Association (KBA) has called for the MPC to hold rates steady.

"Considering the above developments and the balance of inflation risks in the economy, we view that there is merit to keep the CBR unchanged," the KBA stated.

It argued that this "will allow the full transmission of the previous CBR cuts through the market and ensure a non-disruptive transition" of the entire banking sector’s variable-rate loan book to a new risk-based pricing framework by the end of February.

A major banking sector transition is underway. The December MPC noted that the revised Risk-Based Credit Pricing Model (RBCPM), "which will be fully operational by March this year, will improve the transmission of monetary policy decisions."

All existing variable-rate loans must be migrated to the new framework by March 1.

"Banks in January 2026 issued 30-day notices to customers about the transition and are currently recalibrating their systems to reflect these changes," the KBA stated, anticipating a smooth shift.

Fresh data from the Draft 2026 Budget Policy Statement (BPS) reveals the government's total borrowing requirement is projected to hit Sh1,006.6 billion in the 2026/27 financial year. Under its 2026 Medium-Term Debt Management Strategy (MTDS), the State aims to source 82 per cent of its gross borrowing from the domestic market.

This heavy reliance on domestic markets has reignited fears of "crowding out" the private sector. When the government competes for the same pool of local capital as businesses and individuals, it tends to keep commercial lending rates high even if the CBR is lowered.

"The inflation outlook is favourable, but the fiscal side is screaming for attention," said an independent analyst at a leading Nairobi-based investment bank, echoing the delicate balance.

"Treasury is planning to borrow over Sh1 trillion in the next financial year, and that creates a natural floor for how low interest rates can actually go."

The MTDS acknowledges these vulnerabilities, noting that while Kenya’s public debt is sustainable, there is a "high risk of debt distress" with the present value of public debt to GDP standing at 65.3 per cent.

Recent data however, points to underlying economic resilience. The KBA note highlighted that "higher frequency indicators depict a sustained month after month growth in economic activity."

The country's Purchasing Managers Index (PMI) posted levels above 50.0 for the fifth consecutive month in January 2026, signalling continued expansion. However, the Stanbic Bank Kenya PMI fell to 51.9 in January from 53.7 in December.

"Kenyan firms registered solid expansions in activity, but rates of growth dropped to four-month lows," the Stanbic PMI report stated.

There are positive signs in credit markets, building on the momentum noted by the MPC in December. "Credit to the private sector remains on a strong recovery path, growing by 6.3 per cent in November 2025, up from 5.9 per cent in October 2025," the KBA note observed. However, it cautioned that growth is "edging upwards, though cautiously, as banks watch the evolution of nonperforming loans in key sectors."

For President Ruto, the stakes could not be higher, experts say. Having made affordable credit the cornerstone of his Bottom-Up Economic Transformation Agenda, the slow pace of credit transmission remains a political liability, analysts add.

Following the December rate cut, the country's two largest lenders, KCB and Equity Group, reduced their base lending rates to nine per cent.

However, the broader market has been slow to follow, and the average commercial lending rate remains near 14.9 per cent.

Market expectations for Tuesday’s meeting are split. Some analysts side with the KBA's call for a hold to allow the December cut to filter through and ensure a smooth sector transition.

Others argue a further symbolic cut is needed to signal support for the presidency's economic goals. "The CBK wants to support growth, but it cannot ignore the Sh1 trillion elephant in the room," the independent analyst added.

"If the government borrows too aggressively to plug its deficit, the 'Christmas gift' for borrowers seen in December might be short-lived."