A defining moment for the MPC

Proshare

Monday, May 23, 2016 11:48AM/FBNQuest Research

A difficult call for the meeting of the monetary policy committee (MPC) today and tomorrow in Abuja was made more complicated by the public release of the national accounts for Q1 2016 on Friday.

We had penciled in a 150bps increase in the policy rate to 14.50% by the committee to combat rising inflation and the related expectations. Then we learnt that GDP had contracted by -0.4% y/y in Q1 and, more importantly in this context, the non-oil economy by -0.2%.

The committee therefore has to contend with a shrinking economy that is likely to contract further in the current quarter and rapidly rising inflation, as well as exchange-rate policy.

It favours a policy rate that is positive in real terms as an incentive to investment. This thinking drove its hike of 100bps in March. Tightening would also be helpful in sales of FGN bonds at auction (while adding to the FGN’s debt servicing costs).

Another increase, which the DMBs would doubtless pass onto their loan customers, would further dampen household consumption.

The committee could seek to counter inflationary pressures by raising banks’ cash reserve requirement while leaving the policy rate unchanged. We would be surprised if it eased in the face of the GDP data or maintained a neutral stance, given the personal statements of the members over several quarters. On balance, we see a rate hike this week.

The announcement by the NNPC of a new retail price band for sales of petrol/gasoline, based on a “secondary” (rather than parallel) rate, has fuelled talk that a devaluation of the naira exchange rate may be coming.

Financial markets expect it, offshore investors want it and the IMF has suggested it. However, there would have to be a sizeable shift in the MPC’s thinking for a majority vote for a textbook devaluation. We do not buy into the theory that monetary policy is determined outside the committee.

It could be argued that the move by the NNPC amounts to a de facto devaluation. The CBN is known to have considered a second exchange-rate for what it terms non-priority transactions. It has experience of operating two official windows, one supplied by itself and the other from all other sources including the oil companies.

This could come this week or it could be the subject of a new research study. A rate well south of the current official N197 would generate some new flows but would not close the large supply/demand gap.

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