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kenya-bondNAIROBI: Kenya's one-year Treasury bond yield is expected to fall further at an auction this week thanks to heavy subscription which would allow the central bank, keen to bring down the cost of domestic borrowing, to reject less favourable bids.

The Central Bank of Kenya will auction the new one-year bond worth up to 10 billion shillings ($120 million), whose coupon will be set by the market at its sale on March 20.

Fixed income analysts said they expected the paper's weighted average yield to shed as much as 200 basis points to around 16.0 percent from 18.030 percent at its last sale in February.

"In the secondary market the one-year bonds are trading at about 16 percent and, with the high demand we've witnessed at auctions this year, the yield could fall to that level," said Mercy Njoroge, a trader at Tsavo Securities.

"The government is likely to reject more bids. They are trying to bring the cost of domestic borrowing down after they secured the $600 million external loan."

Kenya is looking to borrow $600 million through an international syndicated loan after yields on government securities soared to highs of 20 percent in December from as low as 2 percent in January 2011, making it more costly to borrow domestically.

Edward Munyi, a trader at Suntra Investment Bank, said tight liquidity in the money market could keep commercial banks out of the auction, but he expected demand from foreign investors and pension funds to outstrip the offered amount.

The weighted average interbank lending rate rose to touch 27.2 percent on Wednesday as banks competed for limited shillings in the money market, but eased to 25.4 percent on Friday, although liquidity remained tight.

"The sale of the one-year bond could be a source of additional strain to banks' liquidity. But other players like pension funds and offshore investors would still oversubscribe the paper," Munyi said.

Yields on government securities soared last year as inflation rate rose to peak at 19.72 percent in November, but subscription rates suffered as the central bank squeezed access to credit by hiking its key lending rate in the fourth quarter to 18 percent, where it stands at present.

Inflation has since eased for three straight months to 16.7 percent in February from 18.3 percent in January, pushing yields slightly lower.

Traders said investor appetite for the one-year paper was still high as indicated by the 475 percent oversubscription of 364-day Treasury bills at a March 7 sale, which pushed the yield down 292 basis points to 17.035 percent.

"The one-year paper is still very attractive going by the bids guys put in by for the 364-day bills. We're likely to see similar enthusiasm for the one-year," said a trader at one commercial bank.

Copyright Reuters, 2012