Nairobi — Interest rates are expected to rise in the short to medium term as monetary policy managers move to slow down money related inflationary pressure.

CBK governor Prof Njuguna Ndung'u reckons that money-related inflation has risen significantly to nearly seven per cent signalling that it is time for the bank to "appropriately tighten monetary policy".

In the money market, higher interest rates are used to discourage borrowing by making borrowed cash more expensive - ultimately reducing the amount in circulation.

With the amount of money in circulation having risen above the target five per cent, the monetary authority is expected to raise the Central Bank Rate (CBR) or allow bidding for government securities to rise in the coming weeks to reduce the amount of money in circulation.

The CBR currently stands at 8.75 per cent. Independent analysts at AIG Global Investment said they expect interest rates to keep rising in the short term, which includes the period up to June.

"We expect short term interest rates to go up due to temporary liquidity tightness in Q2, but long-term rates should remain stable." AIG said that the Safaricom IPO was likely to create temporary liquidity distortions as the proceeds are concentrated in the hands of a few banks handling the IPO.

Prof Ndung'u attributed the presence of excess cash in the economy to consumption dating back to the festive December season and last year's election campaigns.

Besides, he said, food and fuel prices have played a major role in raising the cost of living.

Prof Ndung'u however reckons that high prices of goods and services are unlikely to persist beyond May this year when pressure on consumers is expected to ease.

"Statistics do indicate that supply shocks emanating from seasonal cycles are driving current inflation but fortunately, they are a short-run phenomenon whose effects may not be felt beyond the month of May 2008," he said.

Inflation rose to 22 per cent last month - the highest in a decade pushed by high prices of food and fuel. A steep rise in food and fuel prices is in turn attributed to disruption of distribution and supply channels in the wake of a disputed outcome of the presidential election in December as well as the high international oil prices.

Though the CBK said it expects inflation to ease after two months, it warned that it may drop below double digits. Earlier in the year, Prof Ndung'u had maintained that recent political turmoil would not amount to a major disruption in the economy but he has recently admitted that growth could decline to between 4.5 and six per cent.

But even as supply issues are blamed for runaway inflation, it has not been lost on observers that the underlying inflation has also risen to stand at seven per cent - two per cent higher than the target five per cent.

"Serious challenges arising from domestic food supply constraints, high and volatile crude oil prices that are central to production and distribution of goods and services as well as seasonal cycles that affect the production and supply of basic foodstuffs need to be addressed," Prof Ndung'u said.

On interest rates, the CBK said commercial bank lending and deposit rates have varied within a narrow margin, an indication that financial market players consider the recent inflationary pressure transitory.

In the short term, Safaricom IPO is expected to exacerbate surplus liquidity in the money market mainly due to increased foreign currency inflows.

The CBK however reckons that this should be balanced by increased domestic loans to finance the IPO locally.