The relationship between foreign exchange rates and interest rates in Kenya

Abstract

The study sought to understand the relationship of Foreign Exchange Rates on Interest rates in Kenya. The descriptive research design was used. It was a case study of all the Foreign Exchange Rates, Interest Rates, Inflation Rates and Gross domestic Product in Kenya. Central Bank of Kenya (CBK) was the source of information in the pursuit to establish the relationship of foreign Exchange rates on interest Rates in Kenya. The study used monthly average foreign exchange rates, monthly average interest rates. Monthly average inflation rates and Gross domestic product from 2010 to 2014.Multiple linear regression was used to model the relationship between the three explanatory variables and a response variable was used by fitting a linear equation to the observed data. Multiple regression analysis was also used to assess whether correlation exist .The study found that 42.3% of the variation in the dependent variable can be explain by the independent variables, interest rates, inflation rates and GDP,while 57.7% can be explain by other factors outside the model. As a result the research found that there was a positive linear relationship between foreign exchange rates, interest rates and inflation. However there was a negative linear relationship between foreign exchange rates and Gross domestic products (GDP). The study concluded that there was a positive relationship between foreign exchange rates and interest rates in Kenya but not significant. The study recommends that more research be carried out to determine the effect of other factors line relative employment, taxation policies, political situation and market adjustment on how they affect the foreign exchange rates.