The shilling had gained earlier, helped by dollar inflows from the tea sector.

Traders said they expected the shilling to weaken further this week on the Monetary Policy Committee's rate decision and pressure from energy sector dollar demand, but said tight liquidity in the market may support it.

At the market close, commercial banks quoted the shilling at 90.80-90 against the dollar after touching 90.30/40 earlier and weaker than Tuesday's close of 90.50-60.

"The knee-jerk reaction will be a weaker shilling right now, but I think there will be some correction after some time because most of the local players are funding shillings and such a trade is so expensive and counter-productive," said Duncan Kinuthia, head of trading at Commercial Bank of Africa.

"But we cannot rule out a weaker shilling over a period of time.

"The Central Bank of Kenya injected 3.91 billion shillings in reverse repurchase agreements at a rate of 6.25 percent for seven days after cash-strapped banks put in bids worth 16.2 billion shillings for the 3.75 billion on offer.

The bank has injected 42.7 billion shillings into the market in reverse repos since last week.

Traders said they expected increased demand for dollars from oil importers after the country's sole power distributor, Kenya Power, said it would start rationing power from Wednesday due to inadequate supply.

"Demand from the energy sector is expected to continue undermining the local unit considering that we are more reliant on thermal (fuel-based) power generation at the moment," Bank of Africa wrote in a note to clients on Wednesday.

The weighted average yield on the 182-day Treasury bill slipped to 9.799 percent at auction from 9.845 percent in the previous sale, the central bank said.

The bank had offered 3 billion shillings worth of bills for sale. It received bids worth 1.791 billion shillings, a 60 percent subscription rate. It accepted bids worth 1.317 billion shillings.

"That should tell you that we are not seeing instability (in bonds) in the next foreseeable future," said Fred Mweni, Chairman of the bond traders association.

Corporate and government bonds worth 900,000 shilling only were traded on Wednesday, down from 3.042 billion shillings on Tuesday, after the bonds trading was halted due to a technical hitch in the trading system.

"There was a technical hitch at central bank today, so no trades went through. But we expect to see over 5 billion shillings traded there," said Mweni.

Copyright Reuters, 2011