At the close of trade, commercial banks quoted the shilling at 84.65/85 per dollar, a level last touched on July 6, and 0.5 percent weaker than Monday's close of 84.20/40.

Traders said the local currency was expected to weaken further ahead of Wednesday's interest rate decision by the central bank's Monetary Policy Committee (MPC).

"A bit of client activity since late yesterday triggered interbank short covering. The shilling could touch 85.00 easily even before the MPC decision comes out," said Duncan Kinuthia, head of trading at Commercial Bank of Africa.

A Reuters poll of nine analysts and traders returned a median forecast of a 300 basis point cut in the central bank rate after year-on-year inflation fell sharply in August to 6.09 percent, the lowest level since January 2011.

Typically, low interest rates make credit cheaper for importers and easier for commercial banks to hold long dollar positions, putting the shilling under pressure.

The central bank continued to take out liquidity through repurchase agreements (repos), mopping up 5.5 billion shillings ($65.2 million). It received 7.9 billion shillings for the 5.5 billion it had offered on Tuesday.

In stocks, the main NSE-20 Share Index gained for the first time in four sessions, up 1.1 percent to 3,895.62 points.

"Declining returns in the fixed income market, coupled with expectations of a further cut in CBR ... are expected to continue shifting investor interest to stocks," Afrika Investment Bank said in a daily report.

British American Tobacco led the gains, jumping 9.5 percent to 415 shillings, buoyed by an attractive dividend yield, traders said.

In the debt market, government and corporate bonds worth 4.2 billion shillings were traded, down from 4.30 billion shillings on Monday.