Where are interest rates headed? The National Bureau of Statistics (NBS) report for February puts inflation at 17.33% y/y, higher than the print for January at 16.47% y/y, with the critical component of food inflation running at 21.79% y/y.
The upper end of the Central Bank of Nigeria’s (CBN) target range for inflation is 9.00% y/y.
As the CBN argues, inflation is not just about interest rates: structural factors are the key determinant. Insecurity in agricultural supply lines is a critical issue. We believe the following are the main drivers of inflation: structural factors; foreign exchange rates; interest rates; credit growth; commodity prices.
We think that CBN policymakers include interest rates among the factors considered to influence inflation.
After last year’s remarkable decline in market interest rates (1-year T-bill rates fell from 5.40% in January 2020 to 0.15% in early December), rates have been rising this year.
The rise in market interest rates since the beginning of January has been steep (see the chart on the left), with an average of 309 basis points added to the yields of the Federal Government of Nigeria (FGN) bonds with durations of between two and 15 years.
However, over the past month (chart on the right), the yield curve in the secondary market for T-bills and FGN bonds has not changed much, the line waving like a flexed length of rope. Market participants relate that funds still have plenty of liquidity but nevertheless expect rates to continue going up.
This is reflected in the results of the Primary Market Auctions (PMA) of T-bills. Last week the stop-rate for 1-year paper was 6.50% (a yield of 6.95% per annum): two weeks before that the stop rate had been 5.50%. The PMAs are considered more liquid and more representative of rates than secondary-market T-bills.
Is it desirable for market interest rates to trend higher?
In terms of progress towards the rate of inflation, there is little argument. On the other hand, the CBN believes that the low interest rate regime of 2020 was important in alleviating the effects of recession (and indeed, 2020’s recession was lighter than mid-year IMF and World Bank predictions). So, allowing market interest rates to rise now could put a brake on the recovery (the non-oil economy grew by 1.69% y/y in Q4 2020). For this reason, the CBN might tolerate rising rates, but only so far.
Our view is that T-bill rates (in the PMAs) can get to 10.00% per annum by mid-year.
In the meantime, the setting of official rates by the Monetary Policy Council (MPC) of the CBN will continue to tread the delicate path between pro-growth policies and anti-inflationary policies. The current Monetary Policy Rate is 11.5% and the MPC is due to conclude its second meeting of 2020 this time next week. In view of inflation, a cut in the MPR seems unlikely.
In the context of fragile growth, the MPC might retain the 11.5% MPR while allowing market interest rates to climb further. We only rate a small chance of the MPC raising the MPR.