MPC Meeting Preview: A ratification of on-going easing


Tuesday, November 24, 2015 10:23 AM / ARM Research

Macro indicators point to extended economic fragility  
Today, the Monetary Policy Committee of the Central Bank of Nigeria concludes its two-day meeting amidst an increasingly uncertain landscape globally and in Nigeria. On the external front, minutes of the October US Fed meeting revealed a swing in favour of a rate liftoff by December even as the ECB hinted at possibility of cutting rates further to stave off risk of renewed weakness in the Eurozone.

Elsewhere, China cut its policy rate for the sixth time in 12 months, after output slowed to 6.9% in Q3 15, while the BoJ held rates, despite its economy slipping back into recession. On the home front, though output quickened in Q3 15 (+2.84% YoY) relative to Q2 15 (+2.35%YoY) non-oil sector growth decelerated for the 3rd consecutive quarter with the manufacturing sector still in recession (Q3 15: -1.4 YoY). Furthermore, unemployment rate rose for the fourth consecutive month in Q3 15 to 9.9% (+170bps QoQ). On the fiscal side, further down leg in oil prices (-9% since the last MPC and -22% YTD) amplified revenue strain across tiers of government.

The FG’s now expects fiscal deficit to double to N2.1 trillion on lower revenues amidst increase expenditure, while our analysis of states governments show more than half will struggle to meet recurrent expenditure. On a positive note, CPI eased for the first time in 11months to 9.3% (-10bps MoM) and naira remained stable at the interbank even as forex reserves posted modest gains to $30.3billion (+1% since the last meeting). In all, broadly weak macro indicators highlight frailty of the Nigerian economy.

Figure 1: Monthly FAAC (N bln) and oil price ($/bbl)

Cut in policy rate to affirm inflection point of monetary policy
Interestingly, the CBN’s policy moves since the last MPC appear to have taken cognisance of this reality. Despite linking the CRR cut in September to the need to avert potential liquidity squeeze that could be caused by TSA withdrawals, the CBN allowed system liquidity to climb to a 2 years summit of over N1 trillion post-TSA implementation in October.

Specifically, in addition to the N700 billion CRR credit, the apex bank allowed another N850 billion in paper maturity over October and November, without any single mop-up via its usual route of OMO. For us, this decision to allow this level of liquidity (over N600 billion daily average) since the last MPC meeting marked the first real signal of a shift in monetary policy to an accommodative stance from the hawkishness of the past 4 years.

The glut has driven sharp contraction across the yield curve to near five year lows as banks scampered for quality outlets in the face of heightened credit risks. Short-term rates and long term rates collapsed 850bps and 450bps from levels obtainable as at the last MPC to 5.2% and 10.5%, respectively an outcome in sync with apex bank’s governor’s call for lower interest rates.

With short-term rates substantially below the MPR, the CBN’s anchor rate runs the risk of being redundant in the current market environment. More importantly, given that the downleg in market rate is a consequence of the apex bank’s (non-) response to the liquidity build-up, we expect the MPC to formalise the accommodative stance, which essentially commenced weeks ago, with a cut in monetary policy rate.

Furthermore, developments on the fiscal side also support a downward review in MPR. Specifically, amidst waning revenues, the possibility of the federal government’s doubling expenditure in 2016 raises scope for higher level of borrowings and we believe the FG might see domestic borrowing as a more viable option in a lower rate environment. The tactic already has a precedent. At the November bond auction, the DMO took advantage of the low rate environment to sell 40% more paper than planned at marginal rates (10.25% on average) that was the lowest since February 2011.

Indeed, we highlighted the growing harmony between the fiscal and monetary authorities in our Q3 15 Strategy Update and expect the appointment of substantive ministers (majority of whom seemed to favour lower interest rates) to drive a firmer handshake, between the authorities, that would stimulate further downleg in rates. Stacking all these factors together, from weakening macros to depressed market rates and adding the prospect of increasing monetary and fiscal harmony, the question, for us, is not whether the MPC will cut MPR at this meeting, but the quantum.

Balancing the current significant ‘undershoot’ of money market rates relative to MPR against the need to not be too ‘sudden’ with policy changes, we project a cut of possibly up to 200bps. On the other hand, we expect the MPC to hold CRR which, admittedly, has been the preferred tool of control in recent times. We think further downward adjustment to CRR will be dependent on thinning system liquidity, which is unlikely to be the case in the near term, as N560 billion OMO paper is set to mature over the rest of 2015.

In all, we see persistently elevated system liquidity (over N700 billion as at yesterday) as the real evidence of a change in monetary regime, but we believe a rate cut could be the confirming signal that the new regime is here to stay.

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