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PRE-MPC COMMENTARY - Fed, Herdsmen, Elections To Stay MPC Hand

Fed, herdsmen, elections to stay MPC hand                                                                      

Having maintained the status quo so far this year, the Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) sits for its mid-year session this week. Despite signs of slowing economic recovery and impressive moderation in inflation, we anticipate a “HOLD” decision at the MPC meeting, and expect the committee to strike a more hawkish tone. Underpinning this view is the reality of tighter monetary policy in the United States and a growing threat of capital reversals, an expected uptick in inflation in Q4’18, and persistent doubts over the marginal effect of a rate cut on credit growth.                                                                            

United States (U.S.) monetary policy is getting much tighter, much quicker as the Federal Reserve (Fed) increased interest rates by 25bps to 2.0% in June and forecasted a year-end interest rate of 2.5% (previous: 2.25%). This was followed by hawkish comments delivered by Jerome Powell at his semi-annual Senate testimony as the Fed chairman reiterated the apex bank’s desire to further increase interest rates. These developments are likely to induce more capital flight from emerging markets and African countries may suffer more—a trend observed in Q2’18. Given this outlook, further monetary easing could prove particularly harmful to the Nigerian financial sector.                                                                          

Our base scenario sees base effects moderating inflation until August, before trend reverses in September. We anticipate greater food price pressure as a result of the ongoing herdsmen conflict in the Middle Belt. We observed some pressure in May—m/m inflation of 1.3% was the highest since July 2017—and the situation is likely to deteriorate ahead of the 2019 elections. There is a continued push for monetary easing to spur economic growth, a strategy we consider untenable during this period. Whilst monetary easing would reduce debt burdens and borrowing cost and strengthen credit demand, there is little evidence to suggest it would increase the supply of credit given the weak monetary transmission in Nigeria. Commercial banks remain unwilling to lend due to legacy asset quality challenges, and adverse risk environment due to information gaps. This shortfall in the credit growth channel of monetary policy severely undercuts the rationale for monetary easing, particularly as the exchange rate channel is tilted towards tighter monetary policy to defend the naira.