- The IMF anticipates a peak in interest rates at the beginning of 2024, following a slower climb in 2023 across major economies.
- This will likely exert pressure on already struggling currencies across Africa.
- Notably, the US Federal Reserve is expected to witness interest rates reaching around 5.4%, with plans for rate cuts in Third Quarter.
Pressure on the weakening local currencies in African economies may persist for much of this year, with further depreciation against major currencies anticipated until the third quarter.
According to the International Monetary Fund (IMF), their latest interest rates forecast update for major economies covering the period from 2024 to 2028 projects a peak in interest rates at the beginning of 2024. This comes after rates continued to climb at a slower pace late last year.
US Federal Reserve interest rate
For instance, the US Federal Reserve is expected to witness interest rates peaking around 5.4 per cent before initiating rate cuts in the Third Quarter, the lender states. Since 2022, interest rates have increased in the European Union, the United Kingdom, and the United States by at least four percentage points.
The federal funds rate, which is the rate banks charge each other for lending their excess reserves or cash, serves as a target rate set by the Federal Reserve Bank. It usually forms the basis for the rate that commercial banks lend to each other.
However, the Fed funds rate has a more far-reaching impact on the economy, and especially in Africa where countries depend on borrowing and imports. It is a key element of interest rate markets and is used to determine the prime rate, the rate at which banks charge their customers for loans.
Furthermore, mortgage and loan rates, along with deposit rates for savings, are influenced by any changes in the fed funds rate. Changes in the federal funds rate can also impact the US dollar, with its increase typically leading to higher interest rates throughout the economy.
Currency weakness in Kenya
The higher yields then attract investment capital from foreign investors seeking greater returns on bonds and interest-rate products.
The ripple effects subsequently prompt global investors to sell their investments denominated in their local currencies, such as Kenyan shillings, in exchange for US dollar-denominated investments.
The final result is a stronger exchange rate in favor of the US dollar, which then strengthens against local currencies.
The US Fed rate has recorded an almost 17.4 per cent hike in the past year up to January 2024, putting pressure on the weakening Kenyan shilling, which has lost about 35 units of its value year-to-date.
Since it began weakening in early 2020, the shilling has lost approximately 58 per cent of its value against the greenback, a trend that has increased importation costs for importers in the country.
These increased costs are often passed on to consumers, leading to a rise in the cost of living and inflation levels.
As a net importer, this means importers are now incurring an additional $0.367 (KSh58) to buy a dollar for imports compared to early 2020.
Increasing Fed rate projected impact
The IMF’s projection, indicating no imminent relief in the US Fed rate highs, suggests that the trend could persist for an extended period, potentially leading to a continued increase in the cost of living, albeit slightly lower than the peaks observed in 2020-21.
This aligns with the findings of the research unit, Economic Intelligence, which noted a decline in Kenya’s global cost of living ranking for the 12 months ending in September 2023. This indicates that the cost of products and services was comparatively lower than the same period in 2022.
The unit attributed this reduction in the cost of living primarily to the slowdown in inflation as economies recover from the impact of the Covid-19 pandemic.
Kenya’s inflation for December slightly eased to 6.6 percent, down from 6.8 percent in November and the earlier highs of nine percent in the year.
While characterizing the inflation levels during the review period as modest, the research unit also acknowledged an upside risk. It anticipates that in 2024, the delayed impact of interest rate rises will slow down economic activity and, consequently, consumer demand, leading to a reduction in commodity prices.
The IMF’s latest update acknowledges the uncertainty surrounding the inflation outlook. However, it anticipates that most advanced economies will gradually begin easing interest rates by mid-2024.