Effect of interest rates in stabilizing foreign exchange rate in the Kenyan economy
Interest rates, inflation rates and exchange rates are vastly connected. However the interaction between these economic phenomena is often complicated by a range of additional factors such as levels of government debt, the sentiment of financial markets, terms of trade, political stability, and overall economic performance. Economists believe that the actual exchange rate is determined by forces of demand and supply of the corresponding currencies. However studies have given conflicting results concerning movement of exchange rates in relation to changes in interest rates. This study seeks to establish the relationship that exists between interest rates and exchange rates. The main objective of the study is to establish the effect of interest rate in stabilizing exchange rates. Other than demand and supply being the determinant of exchange rate, does central bank play a significant role in stabilizing exchange in its role of controlling interest rates? To achieve this objective other variables including Central Bank Rate, Money supply and inflation rate were considered alongside lending interest rates. Three major foreign currencies which include USD, GBP and Euro were considered in this study. The study used quantitative data and relied on secondary data obtained from Central Bank and Kenya National Bureau of Statistics websites. Kenyan economy was the centre of focus for a period of five years from the year 2008 to 2012.Longitudinal correlation design was adopted and regression analysis was run on multivariate equations to establish the relationship between the variables in determining the exchange rate of USD, GBP and Euro. The findings of the study reveal that not only interest rates have a positive relationship with exchange rate but also money supply has a strong significant effect on exchange rates.