you are rite.. is a a signalling rate...tho banks will not cut rates..the GoK and private sector(kengen and safcom) are competing massively with banks for funds...lending rates will not drop

I think an important question will be the relationship of the rate to inflation. Since they changed the inflation methodology it will be difficult to know how effective it will be in taming inflation (although they insist there's none now), especially when demand-pull factors kick in. They have reduced the CBR rate many times over the last year, pumped in liquidity through omo and reduced the reserve ratio, all in the name of lower the cost of credit and liquidity. Don't see how much more they can do to control banks since the banks don't even need to borrow from them. Watch the public debt figure swell as government spends this economy into growth in 2010.

@VVS What if the government tells you that the real interest rate is higher because of less inflation, would that change the way banks assess lending? But then again investing in government bonds allows the banks to lower loss provisions in their P&L, but the returns on short term government paper are poor (banks are encouraged to invest only in short term paper).

Much like our population, GDP growth, and money supply, the public debt is exponential, (and a prize for anyone who knows why?) so it's in CBK's best interest to keep interest rates low lest the cost of debt service sky-rockets.

And they have the perfect excuse to depress interest rates, which is the new inflation calculation-the same changes implemented in developed markets (such as US in 90s) through the use of flexible inflation methodologies like hedonics (check out this vid http://www.youtube.com/w...uN0&feature=channel by Chris Martenson). But what happens when inflation sets in (will we know no, or will core inflation of 2% look too low for worry). In the year to Sep 2009 bank credit to govt has grown (in value) by 35 bn (26.9% y-o-y), but consumer credit down 3 bn (-6.6% y-o-y), will inflation (demand-pull) climb once banks do what the governor wants, lend to us. When do we see the signal for interest rates to reset higher?

The CBK has not pumped in money through omo over the past three weeks but liquidity is still being targeted (lowering the interbank rate) probably to enable the treasury to finance its borrowing deficit with cheaper funds. The government needs to spend the economy into growth and they may look at the new inflation calculation to overstate economy growth (real GDP).

Interesting article by Mbui Wagacha in jana's BD on public debt.

What I was saying is that banks make more money from lending, but if govt. artificially lowers the cost of credit, they may take opportunities to arbitrage the yield curve, but would prefer the former especially after being given the signal through the lower CBR rate.

The banking system is fairly liquid already as you alluded too and so the normal and horizontal repo markets have been fairly inactive, so what would taking on more govt paper achieve in the repo mart, but to lower loan provisions (since there are none on T-bill, etc as you mentioned).

The GDP (in value) terms is exponential and that is a more interesting indicator than the rate of change that everyone's used to-that's the relationship I wanted you to see, that's there's the imperative to grow exponentially is there to cover debts created-that's the problem with deficit spending and where the new inflation figure may help. There was emphasis on lowering the reserve ratio & CBR to raise liquidity to prevent a crowding out of the private sector, but due to the above factors you mentioned banks are not utilising these excess reserves.

The governor alluded to seeing no inflation problems, which is why he's comfortable lowering the CBR, but all I was saying is if the credit contraction to consumers reverses then the effects will be more clearly manifested (in the CPI). The government can also spend on private producers just as efficiently as the private sector, if it uses the money well on real goods and services. In fact speculative borrowing from ordinary consumers (Safaricom IPO) be just as damaging. Public debt is driving money creation as govt seeks to balance the budget.

Omo can also be used to enable banks to absorb new govt issues, because all the cash it adds become reserves on which the MM can be applied. That's why if you look between May and September you'll find that omo injections correlate very well with government auctions (especially T-Bond) where there were reserve deficits to be supported (to induce new borrowing-net of redemptions). I appreciate you sharing your expertise VVS.

IMHO the CBR is a signaling tool and apart from a few large banks, most don't exploit it. It is through this tool that other crucial rates (savings & interbank) are lowered give the banks the ability to arbitrage the curve. I could be wrong but that's what Ive come to understand. Nway I probably need to ponder on it some more.

So if the real GDP was not exponential, how would we keep up with public debt and money stock that you have indicated is growing exponentially-the interest component on debt alone requires a constant expansion in GDP. Avoiding inflation is done by matching the growth of money stock to the value of goods and services produced in the economy. A common example of these factors not moving proportionally is Zim whose economy declined since 2000, but money supply continued higher. An economic growth rate of 5% per annum doesn't result in the same change in value terms over a five year period, amounts will become increasing bigger as the growth rates are applied on the most recent amount.

I have an two interesting documents that illustrate the function of omo and how they work, if your interested in reading them, just email me at moneyedkenya@gmail.com