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MPC Decision - Monetary policy stance maintained amidst stagflation

• At the penultimate Monetary Policy Committee (MPC) meeting of 2016, all monetary policy instruments were retained at their July levels as MPC members reiterated the apex bank’s principal mandate of price stability and the current limitations of monetary policy in spurring economic recovery. Meanwhile, they stressed the need to allow the effects of the previous 200bps rate hike to crystallize. Prior to the decision, analysts were divided over the appropriate direction of monetary policy. Whilst we intimated a “hold” outcome given prevailing circumstances and Bloomberg Consensus indicated a marginal bias towards tightening, many domestic observers called for looser monetary policy in light of the rapidly deteriorating output growth picture. In contrast, all 10 present members of the MPC voted to hold, compared to a 5/3 split to raise in July.

• With rates in fixed income markets already high (yields on 1-year notes average above 22% in August), the decision to hold, rather than hike, is wise. The effects of July’s tightening are yet to fully crystallize and will be supported by the signal of the MPC retaining current MPR even in a recession. Finally, despite weak monetary policy transmission to growth, we consider a further hike to be imprudent as it may further undermine current fiscal policy.

• The divergence of fiscal and monetary policy underlines the urgency of external borrowing in the face of spiraling domestic financing costs. In the meantime, we expect marginal improvement in the FX market in response to this decision, which may require tight monetary conditions till the end of the year. However, we expect the MPC to revisit the issue by the end of Q1’17 as the effects of fiscal policy, exchange rate reforms, and FPI responsiveness become clearer.