September 22, 2020 / 12:55 PM / By CardinalStone Research / Header Image Credit: Vanguard
The monetary policy committee (MPC) commenced its penultimate two-day meeting on the 21st of September 2020 against the backdrop of weak economic growth, rising inflation, relatively illiquid currency markets, and mild capital inflows. In line with the actions of major central banks across the globe, the MPC has opted for accommodative monetary policy to cushion the adverse impacts of the pandemic. However, the measures failed to prevent a deeper than expected contraction in GDP in the second quarter, increasing the likelihood of some form of monetary response in the ongoing meeting.
A rate hike unlikely despite recent surge in inflation
The MPC uncharacteristically prioritized output growth over other policy objectives of price and exchange rate stability amidst the current crisis. Despite the expected trajectory of inflation over the next 12 months, the MPC may decide to leave rates low in the interim since supply-side and legacy insecurity issues (the primary drivers of inflation in recent months) cannot effectively be tackled by rate hikes. We, therefore, expect the apex bank to continue to target inflation through direct interventions and loan support aimed at addressing supply side structural challenges
Historically, the CBN has raised rates after external shocks to attract FX inflows and stabilize the exchange rate and price environment. However, in addition to nullifying the apex bank's efforts to deleverage its balance sheet, a rate hike may fail to attract sufficient hot monies as investors concern over twin deficits and slow pace of institutional reform pre-date the crisis. Attractive carry yields from peer nations with more robust reform programs further dilutes its appeal. For us, this dilemma is likely the root of the subsisting question on CBN ability to sustain its interventions in currency markets. This concern may be partly responsible for ongoing efforts to obtain more multi-lateral funding and suggestions of a special dollar OMO.
There is a case for a second MPR cut in 2020
We see legroom for another 100bps reduction in the monetary policy rate at the end of the ongoing meeting (40.0% probability). Nigeria's Q2'20 GDP growth of - 6.1%, which vastly underperformed CBN's growth forecast of -1.0%, suggests that the apex bank misjudged the depth of the COVID-induced crisis and could therefore reassess its policy measures. Besides, leading indicators suggest only an anemic pickup in economic activity in the months after the GDP release. Notably, Manufacturing PMI increased to 48.5 points in August (vs 41.1 points in June) but still represented a fourth consecutive fall in the level of monthly economic activity. The non-manufacturing index fared even worse, with macro ramifications compounded by exchange rate pressures, rising unemployment, and higher food prices.
We expect any MPR cut to be accompanied by continued disbursements of funds for earlier announced interventions (including N1.1 trillion to manufacturing and health sectors) and sustained implementation of loan forbearance and other accommodative measures. On the N1.1 trillion intervention fund, we note that the disbursements to the health sector are almost complete (N94 billion/N100 billion disbursed as at July 2020) but there is still ample legroom for increased allocation to manufacturing (N153 billion/N1 trillion distributed as at July 2020). Traction on this front is also likely to improve broad money supply (M3), which is currently below CBN's target of 13.1% for 2020.
As for other policy parameters, an increase in the CRR could curb future speculation on the currency amid incoming OMO induced liquidity glut (40.0% probability). However, the CBN may weigh the impacts of such a move on lending and interest costs.
Inertia is a more likely outcome
Having altered the policy rate only three times in the last 25 meetings, the committee has established a preference for liquidity management through administrative measures. It has also favoured a wait and see approach to allow transmission of freshly administered policy initiatives. Thus, the recent cut in the savings rate from 3.75% to 1.25%, continued disbursement of intervention funds, and the assumption that the worst quarter is behind us could breed familiar inertia at the end of the meeting (60.0% probability).