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Nairobi - The Kenyan shilling weakened on Wednesday as banks squared positions ahead of an interest rate decision, with some traders anticipating the central bank might sell dollars to support the local currency.
At 07:45 GMT, commercial banks quoted the shilling at 88.70/80 to the dollar, compared with Tuesday's close of 88.60/70.
Kenya's inflation rate in August rose to its highest level since June 2012, making it more likely the central bank will lift interest rates in coming months.
Two traders said they expected the bank to keep rates on hold at Wednesday's policy meeting. At its last meeting in July, the central bank held its benchmark lending rate at 8.50 percent.
"There is demand for dollars from banks buying to square their positions before the rate decision," said Sheikh Mehran, head of trading at I&M Bank.
Traders said shilling liquidity conditions had improved due to government departments starting to spend money from the budget 2014/15 (July-June) fiscal budget.
Delays by the government in releasing funds to departments and local authorities caused a liquidity crunch, leading to overnight borrowing rates on the interbank market shooting up.
Chris Muiga, senior trader at National Bank, said demand was rising because the market was now liquid, and it was likely the central bank would enter the market as it did last week to shore up the weakening local currency.
"These are the levels at which the central bank sold dollars to shore up the shilling last week," Muiga said.
The shilling, which has lost about 3% this year, hit its lowest level since December 2011 last Tuesday when it traded at 88.80/90 to the dollar before the central bank intervened.
