Pre-MPC Commentary – Fed, Herdsmen, Elections to Stay MPC Hand


Having maintained the status quo so far this year, the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) sits for its mid-year session this week. Despite signs of slowing economic recovery and impressive moderation in inflation, we anticipate a “HOLD” decision at the MPC meeting and expect the committee to strike a more hawkish tone.

Underpinning this view is the reality of tighter monetary policy in the United States and a growing threat of capital reversals, an expected uptick in inflation in Q4’18, and persistent doubts over the marginal effect of a rate cut on credit growth.

When U.S. rates go high, we go…

“The expected surge in liquidity and likely retrenchment in inflows on account of some external developments appear to be the most potent threats to domestic economic and financial stability in the short-to-medium-term.” – Edward Adamu

United States (U.S.) monetary policy is getting much tighter, much quicker as the Federal Reserve (Fed) increased interest rates by 25bps to 2.0% in June and forecasted a year-end interest rate of 2.5% (previous: 2.25%).

This was followed by hawkish comments delivered by Jerome Powell at his semi-annual Senate testimony as the Fed chairman reiterated the apex bank’s desire to further increase interest rates. The strategy is backed by U.S. economic data. Nearly 1.3 million net jobs were created in H1’18 and the Fed’s favored inflation gauge reached the 2% target in May for the first time since April 2012. Reacting to this tighter monetary landscape, the dollar index rose to a year-high and U.S. 3-month treasury yields closed above 2% for the first time in a decade. These developments are likely to induce more capital flight from emerging markets and African countries may suffer more—a trend observed in Q2’18.

Intervention from President Trump could offer some respite, considering the U.S. president recently expressed his view that U.S. interest rates were too high and could adversely impact the economy and trade balances. However, President’ Trump’s outburst is unlikely to deter the Fed from its path, meaning that Nigeria would have to brace itself for further capital reversals in H2’18 even under the current domestic monetary policy status quo. Given this outlook, further monetary easing could prove particularly harmful to the Nigerian financial sector.

Inflation rebound expected in Q4

“Granted, some spending will stimulate growth; but, excess spending beyond the economy’s absorptive capacity has potentially negative consequences, particularly with respect to inflation.” – Ahmad Aishah

Our base scenario sees base effects moderating inflation until August before the trend reverses in September on account of three factors. Firstly, base effects will wane in H2’18 as inflation in the second half of 2017 was much weaker than the first half. Average month-on-month inflation was 1.55% in H1’17 but just 0.85% in H2’17. Secondly, we anticipate greater food price pressure as a result of the ongoing herdsmen conflict in the Middle Belt.

We observed some pressure in May—m/m inflation of 1.3% was the highest since July 2017—and the situation is likely to deteriorate ahead of the 2019 elections. Finally, sizable fiscal injections in H2’18 and pre-election spending may induce demand-pull inflation.

We admit that delayed budget passage and the furor over outlined spending is likely to weaken the fiscal multiplier, but we still expect a lot of money to be spent on electioneering in the latter parts of the year. Ultimately, we forecast year-end inflation of 11.6%, the same as recorded in May.

Interest rate cut will not improve private sector credit growth

Simply tinkering with the MPR at this current state of the banking sector may not simply translate into more credit for the economy unless there is a way to creatively ‘de-risk’ the targeted real sector of the economy.” Adenikinju, Adeola Festus

There is a continued push for monetary easing to spur economic growth, a strategy we consider untenable during this period. Whilst monetary easing would reduce debt burdens and borrowing cost and strengthens credit demand, there is little evidence to suggest it would increase the supply of credit given the weak monetary transmission in Nigeria. Commercial banks remain unwilling to lend due to legacy asset quality challenges, and adverse risk environment due to information gaps.

Although industry non-performing loan ratio declined from 16.2% in February to 14.2% in April, net credit to the private sector contracted 0.5% in annualized terms, compared to a 2018 target of 5.6%. As some MPC members asserted, banks have been more eager to strengthen their balance sheets than commit to new credits. This shortfall in the credit growth channel of monetary policy severely undercuts the rationale for monetary easing, particularly as the exchange rate channel is tilted towards a tighter monetary policy to defend the naira.

Verdict: Hold