Bond investors have for the first time in eight months demanded an interest rate above 14 percent to lend to government in the bonds market, as high inflation erodes returns in the fixed income market.
In last week’s bond auction, investors asked for a return of 14.23 percent on a reopened 25-year bond, compared to its coupon of 13.4 percent, and 13.31 percent on a 15-year paper, compared to its coupon of 12.75 percent.
This was the first time the yield demand on a bond rose above 14 percent since the sale of another reopened 25-year paper in September 2025.
Reopened bonds normally come with an existing coupon or actual interest rate that was set when the bonds were floated for the first time in the market.
But when investors consider this return to be lower than the level at which they are willing to lend to government they quote a higher rate on their bids, which results in the State offering them a discount on the price of the bonds to compensate for the difference.
Ideally, a unit of a bond is priced at Sh100, with investors getting a return from the paper’s fixed interest rate. However, when a reopened bond pays a lower return compared to what the market is demanding, investors are given a discount on the Sh100 in order to entice them to lend to government.
In the June sale, the higher yield demands were matched by price discounts of Sh2.86 and Sh5.28 per unit of Sh100 on the 15 and 25-year papers respectively.
“Interest rates continue their gradual rise as illustrated by T-Bill auctions and rising yields in the secondary market,” said analysts at Sterling Capital in a note on the two bonds.
“These issues came amid huge budget financing pressure following the downward revision of tax revenues and upward revision of both domestic and external borrowing targets in the March 2025/26 supplementary budget.”
In the Treasury bills auction last Thursday, rates on the 91-day T-bill rose to 8.55 percent from 8.38 percent, that on the 182-day from 8.25 percent to 8.52 percent, and on the 364-day paper from 8.62 percent to 8.72 percent.
The rates on the 91-day and 182-day papers stood at between 7.5 percent and 7.8 percent three months ago.
With inflation rising to 6.7 percent in May from 4.4 percent in March, some investors anticipated that the Central Bank of Kenya (CBK) would announce a rate hike in Tuesday’s monetary policy committee meeting.
The CBK however held the rate unchanged at 8.75 percent for the second straight time, adopting wait and see stance that will likely do little to ease the uncertainty in the financial market.
CBK Governor Kamau Thugge said on Wednesday that it was difficult for the MPC to say with certainty what would happen in the coming days in regard to inflation, citing the ongoing conflict in the Middle East and volatile oil prices.
“We are keeping an eye on the developments with food prices, oil prices and the second round effects on inflation, and on that basis we will take action in the next MPC meeting,” said Dr Thugge.
In its previous MPC meeting in April, the central bank paused a run of 10 consecutive rate cuts due to inflationary pressure from higher energy prices caused by the war in Iran.
When inflation goes up, central banks tend to raise rates in order to reduce the supply of money in the economy and tame demand and rise in prices of goods and services.
These rate hike measures are however more effective in cases of demand driven inflation where higher prices are caused by too much money chasing few goods.
In the current situation, inflation is being driven by supply-side price increases in the form of costlier fuel and imported goods due to the Iran war, meaning that a rate hike would not necessarily yield lower prices in the economy.
For investors in the government securities market however, higher inflation eroded the real returns from their assets, regardless of whether it is demand or supply driven.
They will test the market again for higher rates in the coming week after the CBK reopened a second pair of bonds for sale on Tuesday, seeking Sh60 billion. The 20 and 25-year bonds that were first floated in 2018 and 2021 come with coupons of 13.2 and 13.92 percent respectively, and will be on sale until June 17.