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Pre-MPC Commentary: Will The New MPC Stick To Or Twist?

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Tuesday, April 03, 2018  04.18PM / Vetiva Research 

The inauguration of the new Monetary Policy Committee (MPC) is hugely welcome given the uncertainty around monetary policy since the start of the year. Despite calls for the committee to hit the ground running and ease monetary policy, we consider it more prudent for the MPC to hold back at this time and instead provide forward guidance and greater clarity on their near to medium-term expectation, in line with global best practice. 

In our view (Vetiva), easing at this emergency meeting would be hasty, particularly as general Central Bank of Nigeria (CBN) liquidity management is yet to properly signal a shift towards sustained monetary easing. Therefore, our recommended approach would be for the MPC to provide clarity on rate path and the CBN to follow suit through its Open Market Operations (OMO) in the coming weeks. This should pave the way for a stable shift towards looser monetary policy in Nigeria. 

One eye on Fed activity, but little change there
 
The United States Federal Reserve (Fed) raised interest rates by 25bps to 1.75% at their March 2018 meeting, lifting the benchmark rate 100bps above its level in March 2017. The PCE index, the Fed’s favoured inflation gauge, rose to 1.6% y/y in February, the highest in a year but still below the 2% target. Furthermore, the Fed revealed more bullish expectations for the labour market and economic growth, as well as a more hawkish tone for medium-term interest rates amid impending fiscal stimulus. Whilst these developments point towards further monetary tightening in the U.S., we note that not too much has changed; after all, the Trump fiscal boost was expected in 2017 and simply looks to be coming a year later than anticipated. Still, monetary tightening in the U.S. would continue to pose a threat to capital flows to emerging markets. The upside for Nigeria is the recent improvement in inflation and risk environment which is positive for the risk-adjusted return of investing in the country. 

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Inflation declines, but not in the way imagined
 
Despite the steep fall in headline inflation (from 15.4% y/y in December 2017 to 14.3% y/y in February 2018), underlying inflationary trends are more sticky. Month-on-month headline inflation has remained marooned within the 0.75%-0.80% range for the last six months while underlying annual inflation (stripping out volatile food and energy prices) has fluctuated within a 45bps range in the last eight months – both of which are peculiar for a country with historically volatile inflation. In some ways, this is not so surprising as the main drivers of moderating inflation have been base effects and softening food prices. Moreover, these look to be respectable inflation levels compared to the last two years. Nevertheless, the broader picture warns that we are not out of the inflation woods and we are yet to see a marked change in underlying inflation. February numbers showed stronger signs of moderation – largest drop in core inflation since June 2017 but the medium-term trend cautions against overly aggressive easing.  

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Political and structural constraints should not deter committee
 
The MPC decision is clouded by two factors. The first consideration is of higher inflation at year-end given the likelihood of a minimum wage hike, increased election spending, and waning base effects. This outlook may impose a time constraint on monetary easing as the MPC may need to re-pivot to tackle runaway inflation. The second consideration is the continued doubt over the efficacy of monetary policy transmission in the Nigerian economy. The latter issue should be helped by a shift in federal government debt policy towards external borrowing (to reduce crowding out) and improvement in Nigeria’s credit risk environment (through the push for credit bureaus and collateral registries). All things considered, the recommended decision at this week’s meeting is a “HOLD” with further clarity to be provided on medium-term monetary policy. 

Verdict:
Hold  

Author
Michael Famoroti  of Vetiva Capital Management Limited can be reached vide m.famoroti@vetiva.com

Plot 266B Kofo Abayomi Street | Victoria Island | Lagos | Nigeria| +234-1-4617521-3

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