Temptation of the MPC to hike again

The monetary policy committee (MPC) meets today and tomorrow in Abuja, and again has a difficult call. Since its last meeting in July, the economy has entered a technical recession while headline inflation has continued to accelerate, although the m/m rates have finally slowed. The tightening in July of 200bps on the policy rate was designed to encourage the offshore fixed-income investor. There has been a response but not on the scale to create a fully functioning, two-way fx market.
The committee rediscovered its interest in offshore investors because the new fx regime will not function smoothly without sizeable autonomous inflows to supplement the CBN’s. It knows that a lasting economic recovery requires a properly functioning regime and it has an eye on the diminishing official reserves. Its goal therefore becomes relative exchange-rate stability.

The fastest route to this destination is through investment by the offshore community in naira-denominated assets. Over time, Eurobond issuance and FDI can play a role, and further ahead a recovery in the oil price could prove a game-changer. When we pursue this argument, a rate hike appears likely.

Some might challenge even the discussion of a hike when the economy is in recession. The MPC’s communique in July noted that the CBN “lacked the instruments required to directly jumpstart growth”.  This was a point it has frequently made, although more forcefully than in the past. What led to a rapid decline in annual growth, to 2.8% y/y in 2015, was not monetary policy (in the narrowest sense) but the macro consequences of the slump in the oil price for an ill-prepared economy.

Headline inflation y/y has now accelerated for seven successive months, which in itself could be said to point to tightening. At the same time, the m/m increases have started to slow, to 1.0% in August. This could be attributed to the squeezing of household demand and/or the relative stability in the naira exchange rate since the large adjustment in mid-June.

The MPC operates on majority voting, and tightened in July on a split decision (five votes to three). A higher turnout this week would add to the uncertainty surrounding the conclusion of the meeting. The committee has a full complement of 12 members.

Our call in this difficult environment is that the committee will hike by 100bps to 15.00% on Tuesday. Our thinking is that in its own words its policy has limited impact on growth. While inflationary pressures are easing, its priority is to attract more substantial inflows from the offshore community and so hasten the establishment of a fully functioning fx market.

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