Friday, August 12, 2016 8:40am /Meristem Research
At the end of the recently concluded Monetary Policy Committee (MPC) meeting in the United Kingdom, the Committee voted for a package of measures designed to provide additional support to growth, and achieve a sustainable return of inflation to the 2% target.
Subsequently, the Committee elected to cut the Bank of England (BoE) Base Rate by 0.25bps to 0.25%, introduce a new term funding scheme to reinforce the pass-through of the cut in bank rate, purchase about EUR10bn of UK corporate bonds, while also expanding the asset purchase scheme for UK government bonds by EUR60bn, thus taking total asset purchase value to EUR435bn.
Following UK’s vote to leave the European Union (EU), investors’ confidence and optimism in the economy has weakened, thus resulting in significant capital flight and a consequent fall in exchange rate (post Brexit, the Pound has declined by - 12.13% against the US Dollar, to USD/GBP1.31 as at 10th August, 2016).
The outlook for growth is also expected to be slower in the short to medium term, with growth forecasts pegged at 1.7% and 1.3% in 2016 and 2017 respectively, down from 2.2% in 2015 according to the International Monetary Fund (IMF).
Given the weak economic outlook, amidst continuous decline in UK government bond yields, we anticipate that more existing domestic and foreign investors may seek returns outside the United Kingdom.
As such, we anticipate that the sentiments of existing investors (especially from the advanced economies) in the United Kingdom, may skew towards relatively high quality and high yielding assets such as the US investment grade corporate bonds, in the short to medium term.
Consequently, we expect the demand for high yielding assets in the US and Euro area, as well as US equities to increase in the short term.
Furthermore, we expect the search for high yields to filter into the Emerging Market (EM), considering the relatively attractive yields in some EM economies (such as Nigeria & Brazil), spurred by the significant revenue deficits and increasing demand for external debt in the EM.
Closer to home, we posit that the recent developments in the Nigerian monetary space – introduction of both a flexible FX management system and an OTC FX forward market; and the recent hike in the Monetary Policy Rate (MPR) to 14% – makes investments in the country more attractive, and better positions Nigeria to receive capital inflows.
In addition, given that UK accounted for c.45% of the total capital imported to Nigeria over the past two (2) years, we anticipate a sustenance of this trend as yield seeking investors refocus on the Nigerian Market.
However, we note that Nigeria’s weak growth outlook (IMF forecast of -1.8%), worsened by the subsisting headwinds and weak macroeconomic fundamentals, portend downside risk to increase capital flows.