Easing Cycle Over but Committee to Hold-Off on Tightening

The Monetary Policy Committee (MPC) will be meeting next week (21st and 22nd March, 2016) - for the 2nd time in the year - since its last meeting in January 2016 to review developments in the domestic and global fronts as well as take key policy decisions. This meeting is coming against the backdrop of renewed optimism in the global economy, albeit tepid; sustained sub-optimal domestic economic performance and elevated headwinds on potential real economic growth and consumer purchasing power.

Global economic and market sentiments seem to have rebounded after the initial skepticism that greeted the year on concerns regarding China growth slowdown, bearish commodity markets and policy normalization by the US Fed. Global financial markets which had hitherto been in a tailspin have since calmed with prices of commodities - ranging from Oil to soft metals - rebounding from multi-year lows.  The improvements in optimism have mainly been driven by further dovish moves from Central bankers. The European Central Bank (ECB) during its meeting last week announced that it would expand its quantitative easing program while also slashing interest rates and deposit rate by 5bps and 10bps to zero and -0.4% respectively in order to boost economic activities in the Eurozone. Also, the US Fed’s meeting on Wednesday concluded with committee members leaving policy rate unchanged and unexpectedly cutting its interest rate outlook, highlighting the need to proceed to with caution.

In the domestic economy however, the release of several economic data continue to mirror the current challenges that have beset the country as well as the investment landscape. Irrespective of the dovish stance that has been adopted by the CBN since H2:2015 with the objective to spur credit growth to the real sector and catalyse GDP growth, the pass through effect of this policy thrust has been muted on aggregate economic data. Credit to the Private Sector contracted 0.1% (to N18.9tn) between June 2015 and January 2016 while Demand Deposits has grown 31.0% (to N6.5tn) in the same period; indicating the high risk aversion in the economy, pile-up of excess liquidity and underutilization of productive capital. In the same manner, GDP growth for 2015 more than halved at 2.8% Y-o-Y from 6.2% in 2014 while on a Q-o-Q basis, it ranked the lowest in the rebased series at 2.1%. Much more disturbing was the sectorial GDP which showed that the Industries contracted Y-o-Y during the 4 quarters in 2015 (-2.5% in Q1, -3.3% in Q2, -0.1% in Q3 and -3.0% in Q4). Headline inflation rose to the highest level since 2012 to 11.4% in February 2016, reeling from the impacts of higher electricity tariff, imported and domestic food prices. This has weakened the purchasing power of consumers in an atmosphere of lower per-capital income growth and also lowered real return on investments.

In the financial market, the Nigerian equities market is currently enjoying a short term reprieve with the benchmark index up 4.6% MTD in March majorly due to dividend investing and bargain hunting positioning ahead of corporate releases. The FX market however remained pressured with parallel market rate currently at N326.00/US$1.00 (from N293.00/US$1.00 in January) after recovering from a speculative bout in February which drove rate as high as N380.00/US$1.00. Average liquidity in the money market has remained moderately high but interbank money market rates have been fluctuating widely to CBN’s weekly currency intervention auctions and refunds, as well as intermittent OMO mop-ups.

The most positive developments in the domestic economic environment since the last meeting is the recent rebound in oil prices which touched a year high of US$40.15 today (Friday 18th March) – above the US$38.0/b 2016 proposed benchmark - and traction gained in the passage of the 2016 budget expected to anchor economic recovery. However, we do not think the current prices of oil will do much in closing current account deficit (US$4.7bn in Q3:2015) and fiscal deficit given already pent-up demand and a projected expansionary fiscal year.

We expect the aforementioned gamut of issues in the global and domestic economy to set the tone of discourse at the MPC meeting with committee likely to deliberate on policy measures to lift growth, attract foreign private capital and ease pressure on consumer prices. We expect the MPC to decide between:

Holding all rates constant and continue to harp on structural reforms and policy coordination with the fiscal arm;
Adjusting the MPR upwards by 100bps – 200bps to compensate investors for lowered real return and attract foreign private capital;
Increase the Standing Deposit Facility (SDF) rate by 200bps, while leaving other rates constant, to force an upward movement in the yield curve and mop up liquidity in the financial system.

Whilst acknowledging the need to compensate investors for the depressed real return, we have placed an 80.0% probability on option 1 and 10.0% apiece on Options 2 and 3 due to 1) Committee members are increasingly communicating dovish statements and are likely to rest on the (valid) evidence that current pressure on prices is feeding from cost push factors and not liquidity driven to dismiss the option of using the MPR or SDF instruments to stabilise prices 2) the focus of committee members has shifted from attracting short term private capital that typically responds to tightening 3) a policy tightening without adjustment of exchange rate or allowing more flexibility to deepen liquidity and access will only result in tightening of financing conditions in the economy and pressure cost/prices further.

Like we noted, a much more potent policy mix would be to adjust the exchange rate and restructure the market to allow for more flexibility but as in previous meetings, we do not expect the MPC to consider this given past communications and disposition of fiscal authorities. Regardless, we believe the easing cycle of monetary policy is over but the tightening curve will be less steep.