MPC: A Tale of Constrained Discretion


Wednesday, November 22, 2017 /01.14PM / Proshare Research 

Prior to monetary policy committee (MPC)’s meeting in November, forward guidance had made it clear that a tweaking in monetary policy tools was unlikely.  The Central Bank maintained its position that a tweaking in tools will occur, when the bank has hit its numerical target of 15% inflation. In addition, the echelons of the bank had hinted on policy deviation taking place after the first quarter of 2018.  

Certainly, the time consistency card will still hold till the end of the year as the bank maintained its long run objective. Explicitly, the monetary policy rate  (MPR) won’t bite the bullet any time soon nor will policy reversal occur in November. 

At the end of the meeting it was not surprising to see monetary policy in its usual line asked fiscal policy to provide the desperately needed even keel. What has changed?

Global Economy: Missing Inflation
Fig 1: Inflation across Selective Countries
Proshare Nigeria Pvt. Ltd.
Source: Trading Economies

Inflation across most advanced countries remain low, monetary policy in Europe has failed to spring inflation surprises as it remained broadly below its inflation expectation. Even though growth has been on an uptick, regardless core inflation remains weak.

The recent upward rise in producer prices have been on the back of Dollar appreciation against major currencies coupled with the recent surge in energy prices.  Inflation in the United States fell from 2.2% to 2%, which is still below   the 2.6% threshold for inflation expectation.

The earlier volatility experienced in the CBOE a week ago have gradual weaned from 13.13 t0 10.65, underlining a return to normalcy in the market.  Even though one might be tempted to admit that inflation is on the up end in advanced economies, regardless most advanced economies are still stuck in a ‘’missing inflation cycle’’. 

Moreover, the blistering in private debt to gross domestic product (GDP) and margin loans in advance countries is a growing source of concern.  The threat of wide spread contagion is grim, especially emerging from possible default on private debt. 

Domestic Economy

External Reserves
Fig 2: External reserves
Proshare Nigeria Pvt. Ltd.
Source: CBN

Nigeria’s external reserves have risen to N34.35 billion, the uplift in external reserves is fuelled by the increase in both oil price and production. The buffering in external reserves has provided the bank more manoeuvring space, with more leeway to intervene.

However, such dynamic replenishes the armoury of the central bank with regards to its reactionary position at defending its targeted exchange rate band. At the same time, it also jeopardises the ability to determine the appropriate effective exchange rate trajectory that makes export more price competitive. 

The ripple effect from rising external reserves has led to concurrent rise in total net foreign asset from N 8.74 in July trillion to N9.73 trillion in August. In the same vein reflective of a 11.13% and 6.45% increase in total net foreign asset compared to the previous month and concurrent month of 2016, respectively.

Money Market
The average open buy back rate and call rate   for the month of November stood at 16.93% and 17.o5% respectively compared to the month of October where the average  open buy back and call money rate stood at 39.5% and 35% respectively. The reduced occurrence of money sterilization compared to the month of October coupled with improve Dollar liquidity tampered down the interbank rate.

Proshare Nigeria Pvt. Ltd.
Source: CBN

Regardless, the high cash reserve ratio coupled with the Central Bank’s dynamic monetary sterilization to keep month on month inflation in check, will remain a drag on money multiplication. The fiscal conduit’s intention, to further tap into the foreign capital markets has led to a short circuiting of the crowding out effect.

Regardless, the yields on the risk- free instrument remains an upside risk to corporate bond. Even though it has dipped largely due to investors reshuffling their portfolio, the yield on the risk-free instrument remains high when compared to pre-recession levels.

Evidently, it will be hard to see it slip below the natural rate. Besides the threat of undercutting non-oil revenue in 2018 cannot be written off matched with an unshaved natural rate. It could force the short end of the yield curve upwards, if the fiscal side return to the money market to bridge the gap.  Whatever seems like a short circuiting might not hold for too long, if adjustments are not made on both sides in retrospective to 2018.

PMI and Output  
Fig3: PMI
Proshare Nigeria Pvt. Ltd.

The production manufacturing index for the month of October stood at 55, thereby sustaining 7 months of successive expansion.  New orders stood at 58.4, thereby expanding for 8 months so far. Orders have recorded the highest level of expansion when compared to other components of the PMI index.  At the same time export order remain largely weak, as it consistently shrinks. 

The employment component expanded by 53.1, making it the highest expansion experience by employment component. However, earlier depression in the component matched with an average of 51.13% expansion over the  last 6 month, still  makes it a distance off from  remedying  the already  pronounced   cyclical effect on unemployment. Obviously it is cheery news that the economy grew by 1.4%, digging beneath those surface  figures lay a “dark horse”.

The slump in the financial sector by 5.6%, do flag red lights   as earlier mentioned in our article
going beyond the surface figure. The slump in the financial sector does reflect the on-going emasculation experience in money supply.  Prolonged period of emasculation does threaten financial stability, which could lead to a recapitulation in the cycle. 

Certainly, the idea that monetary policy should focus on throwing its darts on price stability alone, in a country where supply shocks are virile constrain the discretion of monetary policy to nursing its price phobia. 

Unfortunately, monetary policy have admitted that supply shocks exist; neither is the bank willing to lift a finger nor provide room for deviation in its inflation targeting model stirring supply shocks.

As the model is imitated in confronting push factor.  It just depicts how price phobia so far has constrained policy discretion.

Obviously, the bank has meandered effectively from drawn into a time consistency trap, sadly there is a break down in its monetary aggregate and targeted goal. Once again the Central Bank admits that such conflict existing but it is not ready to make the necessary  trade off.  The ripple effect is a lean money supply, putting the real sector under duress.   

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