Monetary Policy: MPC to Hold Rates despite External Sector Pressures

Abdulazeez Kuranga and Gbolahan Ologunro, Economic note 18 March 2022

At a time when fresh headwinds have emerged over the health of the global economy and build-up in domestic inflationary pressures, the Monetary Policy Committee (MPC) is expected to hold its second meeting of the year on the 21st and 22nd of March 2022. We expect the Committee to examine the global economy’s health within the context of withdrawal of monetary stimulus by global central banks amid the ongoing spat between Russia and Ukraine. On the domestic front, short-term inflation expectations will likely discomfort committee members, particularly given the pass-through impact of elevated global energy prices on headline inflation. In our opinion, the Committee will likely lean towards an accommodative monetary policy stance predicated on the need to fully realise gains from previous policy actions geared towards boosting economic recovery. We do not expect the Committee to hike interest rates in response to the hawkish monetary policy currently adopted by global central banks. Instead, we think the MPC will feel it is “too early” to raise the MPR at this meeting.

Hence, the Committee will judge that further assessment of the policy actions of global central banks will be required before commencing its tightening cycle. All in, we expect the Committee to retain the MPR at 11.5% alongside other monetary policy parameters. However, we expect the Committee to strike a hawkish tone in light of the tightening of monetary policy by global central banks and the indirect impacts of the Russia/Ukraine crisis on domestic inflationary pressures.

Favourable Base & Government Interventions Support Growth in Q4-21

The domestic economy grew by 3.98% y/y in Q4-21 (Q3-21: 4.03% y/y), bringing the full-year growth print to 3.40% (2020FY: -1.92% y/y) – reflecting that the economy has recouped all pandemic losses. Decomposing the breakdown, we highlight that the non-oil sector remains the engine of the overall growth.

Precisely, the non-oil sector grew by 4.73% y/y in Q4-21, albeit slower than the growth recorded in Q3-21 (5.44% y/y). For us, the growth reflects gains associated with the (1) seasonality effect in the agriculture sector, (2) sustained normalisation of economic activities, and (3) improved credit to the private sector. Thus, the Agriculture (3.58% y/y vs Q3-21: 1.22% y/y), ICT (5.03% y/y vs Q3-21: 9.66% y/y), Financial institutions (25.19% y/y vs Q3-21: 25.50% y/y), and Analyst(s). Trade (5.34% y/y vs Q3-21: 11.90% y/y) sectors spearheaded the non-oil sector’s growth during the review period.

Meanwhile, the oil sector (-8.06% y/y vs Q3-21: -10.73% y/y) declined for the seventh consecutive quarter given the troika impact of (1) low investments, (2) infrastructure decay, and (3) COVID-19 induced complexities. Notably, crude oil production (excluding condensates) settled at 1.34mb/d in Q4-21 (Q3-21: 1.35mb/d) – the lowest since 2001 when the OPEC started keeping crude oil production records for its members. If we include condensates, crude oil production settled at 1.50mb/d in Q4-21 (Q3-21: 1.57mb/d). We expect the growth momentum to be sustained in 2022FY, albeit moderately, as the impact of the favourable base from the prior year dissipates. As a result, we project the economy would grow by 2.81% y/y and 2.92% y/y in Q1-22 and 2022FY, respectively.

Accordingly, we expect the Committee to reiterate the need for CBN to maintain its current interventions to sustain the recovery of output growth, more so that the PMI readings remain sub-optimal. Therefore, we believe the preceding would induce the Committee to maintain its dovish stance, albeit with a hawkish tone.

Figure 1: Growth in Oil, Non-oil and Real GDP Figure 2: Trend in GDP Growth – Historical & Forecasts (y/y). Source: CBN, NBS, Cordros Research estimates

Inflationary Pressures Biased to the Upside over the Short Term

Although the headline inflation eased marginally in January, given the dissipating impact of festive-induced spending, it increased in February in line with the pass-through effect of higher energy prices on domestic prices. Specifically, the headline inflation increased by 10bps to 15.70% y/y, primarily driven by the core basket (+14bps to 14.01% y/y), which rose to the highest level since April 2017 (14.75% y/y), a fallout of increased utility prices following the surge in global energy prices. Although food prices increased on a month-on-month basis, the favourable base from the prior year ensured prices eased marginally year-on-year. We expect the Committee to express concerns about the pass-through impact of the lingering Russia-Ukraine conflict on domestic prices, particularly as diesel prices continue to soar higher. Besides, the preparation for the 2022 planting season means that the gains from the 2021 harvest season would continue to wane, exacerbating demand-supply imbalances over the short term.

Consequently, we believe the Committee will feel the need to maintain its monetary policy stance to allow its interventions to continue to support improvement in the aggregate food supply. At the same time, we expect the Committee to call on the fiscal authorities to look into the country’s power situation and improve the availability of PMS across the country.

Figure 3: Trend in MPR and Inflation Rate Figure 4: Headline Inflation Historical and Forecast (y/y). Sources: NBS, CBN, Cordros Research estimates

Limited Inflows at the IEW while Pressure at the Parallel Market Lingers FX inflows to the Investors and Exporters Window (IEW) declined by 7.3% m/m to USD1.06 billion in February (January: USD1.15 billion) – the lowest since June 2021 (USD966.80 million). The decline was due to a 35.2% m/m and 2.3% m/m decline across the foreign and local sources. On the local sources, we highlight that CBN’s FX supply to the IEW (-9.2% m/m to USD299.40 million) declined to the lowest since April 2021 (USD143.20 million). The preceding suggests that despite the rally in crude oil prices, accretion to the gross FX reserve has been limited given significantly low crude oil production volume and elevated PMS subsidies.

Accordingly, manufacturers whose FX needs are not met at the IEW recourse to the parallel market. Indeed, exchange rate pressure remains elevated at the parallel market (NGN574.15/USD vs January average: NGN570.14/USD), albeit relatively stable at the IEW (NGN416.32/USD vs January average: NGN417.44/USD).

Since the last policy meeting in January, the gross FX reserves have declined by 1.3% or USD509.50 million to USD39.70 billion as of 15th March. Given the sustained pressure at the parallel market and tepid inflows to the IEW, the marginal decline in the gross FX reserves suggests that the CBN is cautious about 15.87% significantly improving FX supply to the different segments of the FX market amidst the uncertainties surrounding short-term accretion to the reserves.

Overall, we expect the gross FX reserves at current levels to comfort the committee to maintain its current stance as the CBN’s arsenal to defend the Naira remains in a decent position.

Figure 5: FX Reserves (USD billion) & Exchange Rates (NGN/USD)

Global Central Banks Have Moved to a Tightening Phase

Elevated energy prices and lingering supply chain disruptions have continued to exert downward pressures on the rebound in economic activities that was ushered by the relaxation of lockdown rules at the tail end of 2020. The brewing spat between Russia and Ukraine has further magnified the rise in energy prices due to concerns about supply disruptions arising from sanctions on Moscow, given that Russia is the second-biggest exporter of crude oil and the leading supplier of gas to Europe. As a result, Brent, the international benchmark for crude oil prices, has risen above $100.00 levels, a level last seen in 2014. The prices of food items have also increased substantially due to the global importance of both countries – Russia and Ukraine jointly account for 30.0% of the world’s wheat supply.

Consequently, the combined impact of rising food and energy prices is expected to exacerbate global inflationary pressures. Although the tensions between Russia and Ukraine seem to have eclipsed the effects of new mutations of the virus, it is pertinent to note that risk abounds. Based on IF estimates, the global economy is expected to grow slower by 4.4% in 2022 than 5.9% in 2021E. Overall, we expect the Committee to emphasise the impact of the Russia/Ukraine crisis on global inflation and the connotation for monetary policy in advanced economies. In addition, we expect the Committee to express a neutral outlook on the global economy, citing the possible impacts of supply chain challenges, rising energy prices and uncertainties associated with the evolution of the pandemic.

On the policy front, global central banks have shifted grounds to a tightening phase to curb heightened inflationary pressures. This is on the heels of supply-demand imbalances caused by supply chain constraints and high energy prices, which has led to continued deviation from the 2.0% inflation target set by global central banks. For instance, headline inflation hit 7.9% y/y in February 2022– the highest since June 1982 (+8.3% y/y) in the US. In response to this, the US Federal Reserve raised interest rates by 25bps to a target range of 0.25%-0.50% at the end of its latest meeting (16th March).

Similarly, the Bank of England (BOE) raised interest rates for the third consecutive time at its recently concluded meeting (17th March), noting that inflation (5.5% as of January) will remain higher for longer due to Russia/Ukraine crisis. We believe global central banks’ tightening of monetary policy will be a recurring discourse at this meeting, given that emerging and developing economies usually experience capital flow reversals as global financing conditions tighten. Nonetheless, we think concerns will be tethered by the modalities put in place by the CBN to minimise the exodus of FPIs from the economy.

MPC to Hold Rates despite External Sector Pressures

Considering the Committee’s guidance at the last policy meeting in January that it is not in a hurry to switch monetary stance to mitigate capital flow reversals associated with tightening of global financing conditions, we do not expect changes to policy rates at this meeting. While the Bank of England and the US Fed are expected to march on with interest rate hikes, we believe the Committee will stress the need to examine the magnitude of external sector pressures before raising the policy rate as the first line of defence.

We think the Committee will likely lean towards an accommodative monetary policy stance predicated on the need to fully realise gains from previous policy actions geared towards boosting economic recovery. Like the January meeting, we expect the Committee to stress that hiking interest rates to stem capital flow reversals and curtail inflationary pressures would (1) limit the flow of credit to the real sectors, (2) undermine the recovery process, and (3) widen the negative output gap.

All in, we expect the Committee to retain the MPR at 11.5% alongside other monetary policy parameters. However, we expect the Committee to strike a hawkish tone in light of the tightening of monetary policy by global central banks and the indirect impact of the Russia/Ukraine crisis on domestic inflationary pressures.

Kuranga and Ologunro, analysts at Cordros Capital can be reached via and