By Cordros Research
Considering the implications of (1) global central banks’ normalisation of monetary policy, (2) risks associated with the Russia-Ukraine conflict, and (3) the need to attain domestic macroeconomic stability, the Monetary Policy Committee (MPC) voted unanimously to maintain the MPR at 11.5% at its recently concluded meeting. Similarly, the Committee also voted to retain the Cash Reserve Requirement (CRR) at 27.5%, liquidity ratio at 30.0% and asymmetric corridor around the MPR at +100bps/-700bps.
On domestic growth: The Committee highlighted the Q4-21 real GDP growth (3.98% y/y vs Q3-21: 4.03% y/y), driven by the non-oil sector (4.73% y/y vs Q3-21: 5.44% y/y). Similarly, the Committee noted that although the manufacturing PMI was above the 50-point benchmark in February 2022, it moderated slightly to 50.1 points from 51.4 points in January. On the other hand, the non-manufacturing PMI (49.0 points vs January: 49.01 points) remained below the 50-points benchmark due to the lingering security challenges and infrastructural constraints, which have continued to hamper production and ease of doing business in the country. Overall, the Committee expects growth to moderate in 2022FY given the troika impact of (1) rising energy prices, (2) tightening global financial conditions, and (3) pre-existing structural constraints. The Committee, however, expects monetary and fiscal stimulus to remain in place to continue to support the recovery until the risks to output growth and inflation dissipate significantly. Accordingly, the Committee expects the economy to grow by 3.24% in 2022FY, in line with CBN’s estimates which is ahead of our estimate (2.92% y/y).
On Inflation: The Committee expressed concerns about the headline inflation’s marginal increase in February (15.70% y/y vs January: 15.60% y/y), which was driven by the core index following the surge in energy prices (PMS, diesel and electricity tariff). The Committee was cautiously optimistic that with sustained (1) intervention by the CBN in the various sectors of the economy and (2) fiscal support to address structural issues, prices will moderate as output growth increases. Accordingly, the Committee expects inflationary pressure to moderate over the short-to-medium term as the demand/supply gap narrows. In the near term, the Committee urged the NNPC to take urgent steps to ensure an adequate supply of petroleum products to reduce the arbitrary increase in petroleum product prices across the country.
Ahead of the meeting, we expected that the Committee would maintain the status quo to fully realise gains from previous policy actions geared towards boosting economic recovery. However, we stressed that the Committee would likely strike a hawkish tone given the build-up in domestic inflationary pressures induced by elevated energy prices and tightening in global financing conditions. We believe the Committee decided to hold rates constant to provide more room to examine the (1) evolution of the ongoing conflict between Russia and Ukraine and (2) monetary policy decisions of global central banks and their attendant impact on the Balance of Payment. Notably, the U.S Fed raised the interest rate by 0.25% to a target range of 0.25% – 0.50% at its March meeting and left the door open to further rate hikes, a development that raises capital flight risk for emerging economies like Nigeria. Ordinarily, this should mean that the CBN should raise the MPR to mitigate capital flow reversals. However, we imagine that the Committee judged that such a policy move would destabilise the gains achieved with supporting economic recovery. That said, our interpretation of the body language of the CBN Governor at this meeting is that the Committee is not in a hurry to start hiking interest rates to counteract capital flow reversals.
Although the narrowing of interest rate differential between USD and Naira assets may warrant a hike in the policy rate in the medium term, we believe concerns will be tethered by a subdued impact on the Balance of Payments compared to historical periods. Indeed, the CBN Governor revealed that the country did not really benefit from FPI inflows in 2020 when global central banks eased monetary policy in response to the impact of the pandemic. Accordingly, the Committee will feel that the effects of capital flow reversals are unlikely to be severe, as is usually the case in periods of rising rates in advanced economies. Hence, a HOLD decision is still desirable under the current circumstances. In addition, Nigeria successfully raised USD1.25 billion via the Eurobonds market, which would provide some near-term accretion to the FX Reserves and enable the apex bank to mitigate the impact of capital flight on the domestic currency over the short term. In the interim, we expect FPI inflows to the country to remain tepid as interest rates continue to rise in advanced economies. Therefore, we expect foreign investors to sustain weak interest in Naira assets without further adjustment to the USD/NGN peg and hike in interest rate. Ultimately, we believe the eventual change to a tight monetary policy stance would be primarily hinged on the magnitude of external sector pressures emanating from the policy actions of global central banks as they redirect their efforts towards taming inflationary pressures.
Fixed Income: Considering that the outcome of the meeting is in tandem with market expectations, we expect a neutral reaction from fixed-income investors. However, we expect investors to remain wary about duration risk given medium-term expectations of a tight monetary posture from the CBN. As a result, we think investors will retain the strategy of playing at the short to the belly of the yield curve. Looking ahead, we expect frontloading of significant borrowings for the year to result in an uptick in bond yields as investors demand higher yields in the face of increased supply.
Equities: With the MPC meeting out of the way, we believe equity investors will be paying rapt attention to the outcome of treasury bills and bonds auctions to gauge the direction of yields in the FI market. Bullish sentiments have dominated the local bourse thus far in the year, as the ASI returned 10.6% as of 21st March. However, with domestic investors being the dominant players in the market (75.3% market share as of February 2022), we believe sensitivity to an uptick in FI yields will remain elevated in the medium term. As such, we expect sentiments to remain broadly positive until FI yields begin to inch up.
*Cordros Capital Limited