UPDATE 2-Kenyan shilling, stocks climb after rate cut

* Stocks hit a 22-month high

* Shilling seen testing 80.00 level on Friday

* Long-dated bond yields fall

* 91-day Treasury bill yield edges down at auction

(Adds comments, latest prices)

By Richard Lough

NAIROBI, July 29 (Reuters) - Kenyan equities hit a 22-month high and the shilling KES= held onto gains against the dollar on Thursday after the central bank boosted market confidence by unexpectedly slashing its lending rate late on Wednesday.

The Nairobi Stock Exchange's benchmark 20 Share Index .NSE20 closed trading up 1.38 percent at 4398.32 points, with 15 gainers, three stocks unchanged and two down.

"It's a breakout," said independent analyst Aly Khan Satchu, who forecasts a 30 percent increase in the market's value by the year's end.

"The market is pre-empting...the (constitutional) referendum is going to be 'Yes' and buyers are stepping in ahead (of the result)."

In the banking sector, Barclays Bank was up 3.9 percent at 68 shillings per share and Kenya Commercial Bank climbed 2.73 percent to 19 shillings.

The 75 basis point rate cut to 6 percent, which confounded market expectations, was aimed at defusing fears yields on short term government paper were set to rise and sending a strong signal to commercial lenders to lower their own rates.

The central bank has been flooding the market with liquidity to bring Treasury bill yields down in an attempt to force commercial banks to lower their lending rates which averaged more than 14 percent in June. Many traders felt the yield curve on securities had bottomed out and were looking to the bank for a commitment to maintaining low rates. <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ For graphic showing Kenyan shilling verses 3-mo treasury bill here ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

The cut off rate on the 91-day Treasury bill auction edged down to 1.699 at Thursday's sale, in line with traders expectations the rate cut would see short-end yields fall further. Ahead of the rate cut, market players said yields were set to tick up.

The local currency markets closed with the shilling trading at 80.15/25 compared to the 80.60/70 it was quoted at before Wednesday's rate cut.

TESTING 80.00

"It could try and test the 80.00 level tomorrow (Friday). That's a big psychological level," said Pally Mushiri, a trader at Cooperative Bank.

Traders said some had been trimming long dollar positions, partly in response to the euro hitting an 11-week high against the dollar and amid continued optimism east Africa's largest economy would vote yes for a new legal framework.

"Generally sentiment looks positive ... people were generally looking longish and are reducing that position to square or going slightly short," Ignatius Chicha, treasurer at Citi told Reuters.

The shilling, like some other frontier market currencies, has been buoyed in recent days by the euro's strength on the view that there will be a return of investor appetite for riskier assets, analysts said.

The central bank's decision to cut its benchmark rate was seen boosting Kenya's economic outlook as growth picks up and stabilising the money market.

Analysts said they expected yields on long-dated Kenyan paper to decline further in the short term as traders borrowed at low overnight rates to secure higher yields further out. At 1500 GMT, the 10-year yield was quoted down 23 basis points at 5.92 percent and the 15-year down 18 basis points at 6.47 percent, according to bid yields quoted by CFC Stanbic on Reuters.

The draft constitution includes limits on presidential powers and increased civil liberties and analysts say the measures would boost market confidence.

Kenyans vote on the draft constitution on Aug. 4. Opinion polls suggest the proposal will pass, although there is still some caution over whether there will also be violence.

"Once the referendum is out of the way then we can return back to the economic fundamentals," said Moses Kiboi, head of trading at Citi.

(To see ANALYSIS-Kenya markets welcome rate cut, await referendum please click on [ID:nLDE66S0N6]) (Editing by David Clarke, Ron Askew)