Relationship Between Foreign Exchange Rate and Central Bank Rate

Abstract

Central Bank of Kenya (CBK)’s principal objective is formulation and implementation of monetary policy directed at achieving and maintaining stability in the general level of prices which includes the exchange rate. Monetary policy rests on the relationship between rates of interest in an economy. In Kenya the Central Bank’s role is to set a short-term official rate of interest called the Central bank rate (CBR). The CBR serves as a signaling tool on the direction on which monetary policy is taking. This study aimed to establish if there is any relationship between Foreign Exchange rate and Central Bank rates (CBR) in Kenya. This study adopted explanatory research design. The target population of the study was time series data for Kenya on KES/USD Foreign exchange rate and CBR. Monthly nominal data was used for the period from the month of June 2006 to August 2013. Secondary data was collected electronically from the Central Bank of Kenya data base. Data was analyzed using statistical software Strata version 7 and Excel. The findings of the study showed central bank rates for the period of study have a weak positive relationship to the foreign exchange rate and hence have no much effect on the exchange rates. The CBR was thus found not to be an effective tool for exchange rate determination. In view of this, the study recommends the monetary policy committee devises a mechanism in which the CBR can be a signal to both the domestic and exchange rate market.