Policy Variables: MPC to Maintain Status Quo despite Falling Market Rates

Since the release of our Pre-MPC Note last week, two major developments have surfaced in the global and domestic scene with potential impacts on domestic market condition and near term outlook for monetary policy. Whilst we consider these events important talking points as the Monetary Policy Committee (MPC) convenes next week to deliberate, our expectation of the outcome of the meeting remains unchanged as we anticipate committee members to overwhelmingly vote to retain policy rates at current levels.

The first major development is the outcome of the US Fed policy meeting which held midweek. Dismissing the deceleration in US inflation rate below the 2.0% target since the start of the year as a “mystery”, the US Fed Chairman, Janet Yellen, guided on one additional rate hike in 2017 and three more in 2018 in addition to measures to begin slowly reducing the Fed’s US$4.5tn balance sheet. Although the slightly hawkish statement of the US Fed caught many by surprise, markets’ reaction has so far been calm against the backdrop of the strong and synchronized global growth expansion as well as effective use of forward guidance communication by the Fed to guide on a policy path. Thus, US equity markets, which have been on a tear this year, traded flattish on Wednesday and Thursday, although yields have risen on US bonds and Emerging Market sovereign and corporate Eurobonds. Nonetheless, we do not expect the MPC to respond as the likelihood of a large-scale capital flow reversal from emerging markets remains low as long as the US Fed sticks to its guided gradual tightening path whilst other major central banks’ policy outlook remains broadly accommodative.
Contrarily, we consider the recent developments in the domestic scene more significant to the MPC’s discourse next week. Over the last three weeks, rates have been dropping sharply in the Treasury Bills market in response to possible near term easing of monetary policy as well as reduction in supply of longer dated bills since CBN stopped offering 364-day bills at its OMO auctions. Consequently, we have observed a bull flattening pattern (i.e. longer term rates falling faster than shorter ones) at primary and secondary market for Treasury Bills as investors aggressively position in longer-dated bills. At the PMA held mid-week, the 364-day stop rate fell to 17.0%, 152bps lower than the August 30th Auction stop rate, compared to a 15bps and 56bps drop in 91-day and 182-day papers respectively. As demand increases relative to supply, secondary market rates on T-bills have also declined across tenors, down 134bps M-o-M as of market close today. The bullish sentiment in the fixed income market is also noticeable in the bond market where yields have dropped 74bps on average M-o-M across benchmark bonds to 16.2%. Given market sentiments are often leading indicators of policy rate changes, we expect the MPC to take notice of recent movements in the yield curve.
However, as we noted in our Pre-MPC note last week, we believe MPC would maintain status quo on all rates next week given the need to consolidate gains on stabilizing FX and inflation rates. Our expectations are based on the following considerations:

  • Price level remains sticky as high base effect thins out: the National Bureau of Statistics (NBS) Inflation report for August released today indicated Headline inflation marginally decelerated 3bps to 16.01% Y-o-Y from 16.04% in July. M-o-M CPI growth have remained elevated since the start of the year against the backdrop of a food price pressure which took Food Inflation to an all-time high of 20.3% in July 2017. With the economy now running out of high base effect driven moderation in headline inflation, our model projects inflation rate will rise for the first time since the start of the year in September. Given supposed price-anchored monetary policy regime, the MPC is not likely to cut benchmark rate in a period of rising inflation expectation.
  • MPR has become a less effective Monetary Policy Tool: the case for easing via benchmark rate reduction becomes weaker if the current disparity between the benchmark rate and short-term fixed income yields is taken into consideration. Although the recent bullish streak in the fixed income market has narrowed this spread, it is not enough to justify a cut in interest.

While our medium term outlook favours a gradual monetary easing, we believe the stabilization of the FX market is paramount to achieving monetary policy objectives. The FX market, despite improvements recorded so far in the year, is still in a fragile state as the CBN is yet to harmonize all rates at the official market. As such, in the event that a unified rate is not achieved, monetary easing poses a threat for FX stability. Furthermore, the current realities of Nigeria’s budget deficit, suggests the need for the fiscal authorities to continuously fund this disparity which current tightening stance enhances; though at a higher cost to government.
In light of the above, the more rational decision we foresee the MPC making is to maintain status quo and continue to consolidate on gains in the FX market. Hence, we believe the outcome of the 5th MPC meeting would be to:

  • Retain the MPR at 14.0%;
  • Retain the CRR at 22.5%;
  • Retain the Liquidity Ratio at 30.0% and
  • Retain the Asymmetric corridor at +200 and -500 basis points around the MPR.