Economic Recovery Still Fragile

The Monetary Policy Committee (MPC) held its fourth meeting for the year on the 24th and 25th July, 2017 and much in line with our expectation, status quo was maintained on all key rates as the committee noted that the recent gains recorded in the economic landscape remain fragile and could be disrupted if adequate fiscal and monetary policies are not implemented to complement the recovery. Consequently:

  • MPR was retained at 14.0%;
  • CRR was retained at 22.5%;
  • Liquidity ratio was maintained at 30.0%; and
  • The asymmetric corridor around the MPR was maintained at +200 and -500bps.

In our view, the decision was the most appropriate option open to the MPC in light of the fragile state of the economy despite the recent improvements in the FX market as well as general price levels. Given the broad consensus on the expected outcome of the meeting, the impact of the decisions across the various markets has been muted.

In the equities market, investors' main focus will be on the developments in the FX market, particularly with regards to the sustainability of  FX interventions by the CBN as well as flexibility of the Investor's & Exporters’ FX window (I&E Window). Following the launch of the I&E FX window, investor sentiment has been boosted and this was reflected in Q2:2017 foreign portfolio inflows data which showed portfolio inflows in equities surged 146.4% Q-o-Q to N153.6bn from N62.3bn in Q1:2017 while the All Share Index has appreciated 37.2% YTD. Although most value stocks appear to be more fairly valued relative to pre-crisis level, we still forecast a modest single digit return in the equities market in the last five month of the year if the FX market stability is maintained as expected. In the fixed income market, yields have remained elevated despite moderating Headline Inflation rate, and we expect them to remain so as the CBN will likely keep financial system liquidity tight – via aggressive OMO auctions - in order to attract portfolio flows and maintain stability in the FX market. Nonetheless, we expect fixed income investors to aggressively position in long duration bonds in anticipation of a medium term easing of monetary policy.

Our Outlook
With only 2 MPC meetings left for the year, in September and November, there is an increasing likelihood that status quo would be maintained on all policy rates till the end of the year, given the fragile nature of the FX market rebound and negative inflation surprises in the past five months. In a public speech delivered by the CBN Governor last week at the University of Nigeria Nsukka (UNN), Governor Emefiele referred to the three anchors to drive CBN policies in the near term: FX market stability, Food inflation and Fuel prices.

The recent uptick in domestic crude oil production has been the one of the major drivers of rebound in FX market liquidity, but the downside risk which increased shale production poses to crude oil prices and domestic crude export limit remain headwinds to macroeconomic stability. Also, Headline Inflation figures have disappointed since March, largely due to seasonality driven food price pressure which is partly offsetting moderation effect of Consumer Price Index (CPI) high base. Regardless of these two factors aforementioned, Monetary Policy Rate has become a blunted policy - with OMO clearing rate taking its place – given the significant spread between short term market rates and CBN discount window rates. As it were, harmonizing the various FX market windows to have a single market for all transactions is the only trick left in the monetary policy playbook. Yet, the high sensitivity of petroleum product prices to interbank exchange rate is a political decision the CBN will likely give considerations for before loosening the belt on liquidity tightening and devaluing official rate. Hence, we believe the odds favour the MPC maintaining policy rates at current levels in the last two meetings.