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A Compelling Case for Another Hold from the MPC

Monetary Policy	1497 VIEWS
Monetary Policy
1497 VIEWS

Monday, January 25, 2021 / 08:50 AM / By FBNQuest Research / Header Image Credit: CBN

Today the monetary policy committee (MPC) opens its latest meeting. It created two shocks last year with policy rate cuts of 100bps in both May and September. They may have been warranted in view of the economic slowdown (although its origins have been the external shock of the Covid-19 virus) but sit uncomfortably with the steady rise in inflation since August '19. The headline measure has now accelerated y/y for 16 months in succession, to 15.75% in December. Easing in the MPC's own words helps to create excess liquidity and adds to inflationary pressures. A third cut this week is therefore highly unlikely, particularly when we recall the CBN's mission to achieve and maintain price stability. We feel therefore that the committee this week will again opt for 'hold' and 'wait and see' with an unchanged policy rate of 11.50%.

The CBN has not adopted formal inflation targeting but operates a reference range of between 6.00% and 9.00% y/y for the headline measure. This has not been attained since April '15 and, even if we were to apply the range to the core (non-food) measure, not since October '19. It is no surprise that the committee has not mentioned the elusive range for many months.

Food price inflation is now approaching 20% y/y, and there is worse to come. The drivers are supply-side and are a combination of the old (poor roads, and insecurity in growing areas) and the relatively new (rises in the retail price of gasoline and the protests in October).

We understand that the CBN's house forecasts see another rise for the headline measure in the January report from the National Bureau of Statistics. We see a peak a little later, in March at 16.69%. The communique this week may well share revisions to the CBN's house forecasts.

There is a plausible counter-argument that the acceleration in inflation is the consequence of factors beyond the influence of monetary policy. The MPC itself sometimes makes this point and we have a lot of sympathy with it. Yet we cannot forget the reference range or overlook the CBN's mission.

In the EM universe a good number of official rate-setting bodies cut rates in response to the virus in 2020, supporting a fiscal stimulus in many cases. They also wanted to be seen to be responding, which was probably true of the MPC, too.

On past form, the committee will provide updates on the financial health of deposit money banks (DMBs), and the CBN's expanding development finance role. By its circular dated 01 December, the CBN announced the creation of special bills as additional tools for liquidity management. It is too early to say whether the measure has had the desired effect of boosting DMBs' lending, and thereby reinforcing the progress achieved by the CBN's tightening of the loans-to-deposit ratio since May '19.

We do not expect much commentary on the fx regime in the communique. This is CBN territory (although the top ranks of the CBN are represented on the committee). If there was to be a change in direction, which is not our view, the MPC would not be the messenger.

The communique in November noted that the orthodox response to rising inflation would have been to tighten. However, the committee declined to raise its policy rate, it added, because of the negative impact on any recovery in output and on the CBN's agenda of encouraging credit expansion at affordable rates. Both arguments remain potent in our view.

It would be very difficult for the committee to ignore the inflation numbers, which is our principal reason for calling a verdict of 'no change'. If we have an extended period of disinflation, we could still get a rate cut later this year.