Higher Interest Rates - Necessary But Not Sufficient to Curb Inflation

Sunday, February 14, 2021 08:00 AM / by FDC Ltd/ Header Image Credit:Investopedia

It appears the era of low interest rates has finally come to an end. Nominal interest rates are gradually increasing in the Nigerian money markets on tighter liquidity. So far in 2021, the average opening position of banks has fallen by 12.6% to N479.68bn, relative to December's average of N548.85bn. This is on the back of the CBN's increased mopping up activities.

The CBN is seen to be using more of its traditional monetary policy tools such as OMO bills, CRR debits, etc to address price and exchange rate stability while keeping its benchmark interest rate unchanged. The outcome has been an increase in the yields of secondary market OMO bills from as low as 1.5% to a range of 7% to 10.1%1. Also, short term money market rates of OBB and ON have increased to above 10% for the first time since a brief stint in September 2020.

Implications

There is an inverse relationship between interest rates and stock prices. As returns on investment (yields) start to increase, there will be a gradual shift from equities to the fixed income market. This is also occurring at a time when corporate earnings are being released. A combination of weak corporate results and a rise in interest rates could be the pin that finally bursts the stock market bubble.

The reduction in naira liquidity and resultant increase in interest rates will reduce the demand for dollars. This is positive for exchange rate stability and should lead to an appreciation of the naira and reduction in imported inflation.

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