Kenya has renewed its pressure on commercial banks to reduce lending rates by cutting the benchmark rate to 16.5 per cent, citing slowing inflation and currency stability.

The Central Bank of Kenya (CBK) on Thursday slashed the Central Bank Rate (CBR)—the rate at which the regulator lends to commercial banks—from 18 per cent while warning the country’s economy was still facing risks.

The cut should signal commercial banks to ease interest rates to borrowers.

READ: Rwanda, Uganda, Kenya lending rates remain high

The benchmark rate was held at 18 per cent for six consecutive months, since December 2011, when the shilling was volatile in trading to the dollar and inflation hit new highs.

But inflation has been easing in the past few months and the shilling has gained stability in trading to the dollar prompting the CBK to cut the rates.

Kenya’s inflation rate eased marginally to 10.05 per cent in June, from 12. 2 per cent in May, pulled down by falling food and fuel prices, the Kenya National Bureau of Statistics said last week.

But the CBK said Kenya’s economy was still threatened by external and internal factors.

“There are still potential threats and risks to both consumer prices and exchange rate stability which could increase inflationary pressure” said the CBK’s Monetary Policy Committee (MPC) after its latest meeting.

“The outlook for global economic growth has weakened in recent weeks as some of the risks around the eurozone crisis have materialised while the credibility of the relief packages is yet to be established.

"These developments continue to pose a risk to the demand for Kenya’s exports as well as foreign earnings from tourism, their receipts have traditionally supported the exchange rate” said the MPC in a statement.

Kenyan monetary officials, who have set 9 per cent as the short-term inflation rate target have been cautious on loosening the monetary policy too quickly, over fears that non-food-non-fuel inflation and the unstable shilling were potential risks to the inflation figures.

Analysts expect CBK to cut the rate further in the coming months. “The holding of the next MPC now opens the way for another outsize rate cut to follow, with the authorities granted additional time to gauge the impact on both the forex market and the wider economy,” said Razia Khan, Standard Chartered’s Head of Regional research, Africa.

“We expect market reaction to the rate cut to be overwhelmingly positive. With CPI having effectively fallen to 10 per cent there was plenty of room to cut the CBR, which was previously at a peak of 18 per cent, ” said Ms Khan adding the rate cut was a surprise to the markets.

With the CBK mopping up excess cash from banks, she said, the regulator is likely to remain well in control of the situation.

The non-food-non-fuel inflation- an inflation measure that excludes volatile items that are not subject to the monetary policy- increased from 9.94 per cent in April to 10.27 per cent in May.

A rise in inflation and the resultant increase in CBR pushed commercial banks to double their interest rates on loans from last year’s average of 15 per cent to about 28 per cent currently, leading to a slowdown in loan uptake among the private sector.

The slowdown in private borrowing has contributed to a slowdown in the economy, analysts said with the government projecting the economy will grow at 3.5 per cent to 4.5 per cent this year, compared to 5.8 per cent the previous year.

The CBR cut is expected to prompt banks to reduce their lending rates, a move that could push up uptake of loans.

Increased credit to the private sector with the cost of borrowing falling would boost the financial services and construction sector, which posted a decline in the 2012 first quarter growth compared with the same period last year.

The CBK’s decision to slash the CBR came hours after China and the European Central Bank (ECB) cut their benchmark lending rates and days after Uganda took a similar move.

Uganda’s central bank on Tuesday cut the benchmark lending rate by one percentage point for the second month in a row, seeking to stimulate economic growth as inflation eases.

The Bank of Uganda (BOU) lowered the Central Bank Rate (CBR)to 19 per cent from 20 per cent. Uganda’s economic growth is projected to grow by five per cent this year compared to 6.7 per cent registered in the previous year.

Uganda’s headline inflation continued on the downward trend after it slowed from 18.6 per cent in May to 18 per cent in June aided by a reduction in food price index that fell by 3.4 per cent.

ECB cut its lending rate to 0.75 per cent the first time it has fallen below 1 per cent, in an attempt to kick start growth of the stalled eurozone economy.