May 30, 2013 / 2:07 PM / 4 years ago

Kenya's hunger for imports risks more central bank forays

* Reuters poll sees shilling falling to 88 per dollar by year-end

* Kenya's current account deficit weighs on currency

* Weaker shilling could signal end to rate cuts cycle

By Kevin Mwanza

NAIROBI, May 30 (Reuters) - Renewed economic activity following a smooth presidential vote is driving demand for imports in Kenya, weakening the shilling and prompting wariness about the central bank's response, including more interventions.

Kenya's central bank intervened for the first time in four months on Wednesday and currency traders in east Africa's biggest economy said in the aftermath it is likely to do so again if the shilling starts to decline.

The shilling had fallen 1.7 percent in just over a week to an eight-week low of 85.25/45 per dollar before Wednesday's intervention, tumbling on strong demand for hard currency from importers,

It was at 85.00/85.20 on Thursday, slightly weaker than its 84.85/84.95 close the previous day. Traders viewed this as stable but said the bank would come in again if the weakening trend picked up.

"The central bank is on top of the game and might keep intervening whenever the shilling comes under pressure," said Ignatius Chicha, head of markets at Citibank.

"We are going to have more demand than supply as we see resumption in economic activity."

Demand for imported goods has picked up along with the economy since it became apparent that the March election was not going to lead to the kind of violence the followed the previous one.

But this could weigh on the shilling and could feed into inflation if left unchecked.

In late 2011, the central bank was forced to hike interest rates sharply to rein-in imported inflation that had pushed the shilling to a record low of 107 per dollar in October that year.

At the time, the current account deficit - the difference between a country's imports and exports - had risen to above 10 percent. The current account deficit stands at above 12 percent of GDP, driven by increased local demand for foreign goods.

Peter Mutuku, head of trading at Bank of Africa, said the shillings depreciation was inevitable "because of the current account mismatch".

The shilling is still 1.6 percent stronger to the dollar so far in 2013, but is widely expected to weaken by year-end, pressured by Kenya's persistently high current account deficit.

A Reuters poll of eight analysts and traders gave a median forecast of 88.00 shillings per dollar by year end.

The central bank has remained active in the market, regularly sterilising liquidity through actively soaking up liquidity since last year to support the shilling by making it slightly expensive to hold long dollar positions.

Central bank has also been selling hard currencies even as it cut its borrowing costs by 950 basis points since July 2012 to support the economy.

Some traders said a weaker shilling could tempt the central bank to reverse course on a cycle of interest rate cuts.

"We could see interest rates go back up but that is a last resort because they (central bank) are keen on growth at the moment," said a trader at one commercial bank.

However, for now, they said the bank's foreign exchange reserves of at least 0.27 months cover above the statutory four months worth of import cover, had given it room to sell even more dollars in the market.

"Looks like the central bank has managed to cool off excess demand for now and is keenly watching the market," said Dickson Magecha, a trader at Standard chartered Bank. (Editing by James Macharia/Jeremy Gaunt)

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