As Cardoso is ready to chair his first MPC meeting Monday, Matters Arising
The Monetary Policy Committee (MPC) is scheduled to convene on February 26th and 27th, marking its inaugural meeting for the year and the first for the current CBN governor, following two postponements in the latter half of 2023.
This will also be the first session of the newly constituted committee since the change of guard at the Central Bank of Nigeria (CBN). We anticipate a decisively hawkish stance from the MPC regarding interest rates, aligning with the CBN’s commitment to achieving price stability. Our projection is for a significant increase in the monetary policy rate by 150bps while leaving other parameters constant. The anticipated increase in the policy rate would be in contrast to the prevailing global trend, where many central banks are scaling back on rate hikes and contemplating reductions. We expect the MPC’s decision to be primarily influenced by the soaring inflation, which rose to a multi-decade high of 29.90%, and the depreciation of the currency.
GDP Edges Higher as Oil Sector Rebounds
Nigeria’s economy grew by 3.46% in Q4-23, coming in higher than the previous quarter’s growth of 2.54% y/y. This brings the total annual growth rate to 2.74%, lower than last year (2022: 3.10%). We highlight that the GDP growth was primarily driven by the rebound of the oil sector (+12.11% vs Q3-23: -0.85%) after fourteen consecutive quarters of negative growth. The recovery of the oil sector is attributable to the increase in oil production (1.53 mb/d vs Q4-22: 1.35 mb/d) primarily due to increased efforts by the government to curb crude oil theft and pipeline vandalism, while also driving increased investments in offshore oil assets. The non-oil sector also grew faster by 3.07% (Q3-24: 2.75%) driven by improved economic activities in the agriculture and manufacturing sectors given the harvest period and festivities usually associated with the last quarter of the year. We expect the MPC to note the economy’s resilience in the face of heightened inflationary pressures, elevated domestic interest rates and the paucity of foreign exchange, thus giving room for further increases in the policy rate. The committee is also anticipated to consider the resurgence of the oil sector, given the uptick in oil production, while expecting the trend to continue as the government intensifies efforts to raise oil production.
Inflation Risks Remain Elevated
Headline inflation rose by 98bps to 29.90% in January 2024 (December 2023: 28.92%), marking the highest print in at least twenty-five years. The main drivers were (1) the depreciation of the naira exchange rate, (2) logistics constraints induced by higher energy prices, and (3) heightened insecurity in the food-producing middle-belt region. Food inflation recorded the highest increase, ticking higher by 148bps to 35.41% in January (December 2023: 33.93%). Core inflation recorded an increase of 53bps to 23.59% (December 2023: 23.06%). On a m/m basis, inflation printed at 2.64%, 35bps faster than the last m/m increase (December 2023: 2.29%) and the highest monthly print since August 2023. We expect the MPC to highlight the sustained inflationary pressures due to the exchange rate pass-through effect, given the significant depreciation of the exchange rate and the jump in energy prices. The committee will also highlight the constant depletion of food supplies, exacerbated by increased conflicts in the food-producing region and urge the government to take immediate steps to alleviate the insecurity issues.
Naira Remains Under Pressure Despite CBN’s Efforts to Stabilise the Market
The currency has remained under pressure against the greenback in the foreign exchange market in 2024FY after the naira was implicitly devalued for the second time in seven months by about 40.0% at the Nigerian Autonomous Foreign Exchange Market (NAFEM) following the revision of the rate calculation methodology by the FMDQ.
We note that the decision to move to a more market-reflective exchange rate system was guided by the aim of reducing the official-parallel gap – which again widened after the first adjustment in July – and increasing transparency in the official market. However, the parallel market rate has continued to overshoot the NAFEM rate, reaching a new low of c.NGN1,900.00/USD during the year, whilst the NAFEM rate traded within the range of NGN1,348.63/USD – NGN1600.00/USD.
We attribute the constant weakness of the naira to the insufficient supply of greenback in the foreign exchange market amid the CBN’s inability to intervene sufficiently in the market. We highlight that the CBN has resumed FX sales in the last two weeks, having previously sold in October 2023. However, the quantum of the intervention (c.USD86.00 million weekly), which is lower than the pre-pandemic average level (c. USD1.26 billion weekly), remains insufficient. We point out the increased efforts of the apex bank to clear its backlogs. However, this has not yielded sufficient confidence, thus causing continuous currency speculation. The MPC is expected to attribute the weakness of the naira to increased speculation and money supply saturation while restating its commitment to settling all remaining backlogs, employing its policy tools to manage system liquidity whilst maintaining transparency and price discovery at the NAFEM market in a bid to stabilise the exchange rate against the greenback.
Central Banks Expressing Caution in Lowering Interest Rates
Even though inflation is declining in advanced economies (remains above target), central banks in developed economies are cautious about switching policy stances towards accommodative. The US Fed released the minutes of the meeting held on January 30 – 31, where it held its rate steady at 5.5% for the fourth time in a row. The minutes buttress our view and indicate that the Fed remains cautious and needs evidence that inflation risks are muted before implementing any rate cuts. Given the Fed’s caution on interest rate cuts, we expect the committee to keep its rate steady until May when inflation is much closer to the Fed’s target of 2.0%. Similarly, the ECB held rates steady at 4.5% for the third consecutive period and highlighted the committees’ unwillingness to reduce interest rates, characterising it as a premature move in its minutes released this week. The officials noted the risk to its credibility and reputation if inflation reverses to the upside after lowering interest rates. Irrespective of the committee’s pessimism about reducing interest rates, we think the ECB will likely begin rate cuts in April, given the lull in economic activities in the zone as high borrowing costs weigh on consumer demand and China’s economic downturn negatively impacts the zone’s exports.
In the United Kingdom, we opine that the Bank of England will start to lean towards a dovish stance given that its economy is now technically in a recession (Q4-23: -0.1% vs Q3-23: -0.3%). Whilst the sticky inflation in the UK (December 2023: 4.0% vs January 2024: 4.0%) may put the BoE in a tight situation, we think a cut in its policy rates by 25bps in its meeting in March is likely to happen. We envisage the MPC to identify the reluctance expressed by Central Banks in advanced economies to begin rate cuts as well as the elevated risks to global inflation following global supply chain disruptions induced by the heightened geopolitical tension across several regions and thus expect interest rates in the global economy to remain high over the short-term.
MPC to Raise Policy Rate by 150bps
Although the last MPC meeting was held in July 2023, there has been a significant increase in interest rates in the fixed-income markets towards the inflation rate, signalling the CBN’s hawkish stance against inflation. The CBN has issued OMO seven times in 5 months to mop up excess liquidity in the system. In recent primary market auctions, the apex Bank has over-allotted markets, particularly in the Treasury bills market, pushing interest rates to record highs. Given these moves, the heightened level of inflationary pressures and the increased volatility in the exchange rate, we think that the MPC will maintain a hawkish stance, increasing the policy rate aggressively by 150bps in its meeting next week, pushing the policy rate to 20.25%.
