The Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) is expected to hold its third meeting of the year on the 20th and 21st of May. As in previous meetings, we expect the Committee to consider developments in the global and domestic economy since the last policy meeting.
On the global scene, interest rates remain elevated amid the ongoing geopolitical tensions. Domestically, although consumer prices have slowed on a month-on-month basis, we note that inflation risks are skewed to the upside due to the volatility of the naira in the foreign exchange market and the anticipated review of the minimum wage.
Hence, we anticipate the MPC to tighten its monetary policy, albeit moderately, to manage inflation expectations, tighten monetary conditions and reduce the negative real interest rates. Our base expectation is for a 100 basis points increase in the MPR whilst holding other parameters constant.
GDP to Maintain Positive Growth Trajectory in Q1-24
Judging by the Stanbic IBTC’s Nigerian Composite Purchasing Managers’ Index (PMI) report, business activities improved in Q1-24 relative to the previous quarter amid high inflationary pressures and tight monetary conditions. The headline PMI averaged 52.17 points in Q1-24 compared to the average of 49.93 points in Q4-23. Nevertheless, we highlight that business activities showed signs of weakness as the composite PMI fell to 51.10 points in April from 54.50 points in January. This suggests the impact of heightened inflationary pressures on business activities and consumer demand. Looking ahead, we expect the Composite PMI to remain above the 50-point threshold partly due to reduced FX constraints and improved consumer demand supported by a potential increase in wages.
On the other hand, the oil sector relatively underperformed as domestic oil production fell by 13.1% to 1.45mb/d in April from 1.64mb/d in January. Whilst structural factors such as oil theft, pipeline vandalism, and infrastructure decay remain, we think that the delay in concluding the various divestment deals between International Oil Companies (IOCs) and their Indigenous counterparts may be weighing on domestic oil production. Oil production (including condensates) averaged 1.54mb/d in Q1-24 (Q4-23: 1.53mb/d | Q1-23: 1.51mb/d), potentially leading to a y/y estimated growth rate of c. 2.0% in Q1-24.
Consequently, we revise our GDP estimate upwards to reflect the improvement in the non-oil sector amid a lower-than-expected performance in the oil sector. We estimate a GDP growth rate of 2.87% (Previous: 2.30%) in Q1-24 (Q4-23: 3.47% | Q1-23: 2.31%). We expect the MPC to acknowledge the lull in economic activity, given the impact of sustained price pressure on the non-oil sector as well as the insecurity and IOC divestments in the oil sector. However, we expect the Committee to remain optimistic that GDP growth will remain positive despite the economic headwinds, providing headroom to tighten monetary policy further.
Naira Appreciation Slows Pace of Increase in Consumer Prices
Headline inflation maintained an upward trend in April, edging higher by 43bps to 33.69% y/y (March: 33.20% y/y). Nevertheless, we note that on a month-on-month basis, prices slowed primarily due to (1) reduced exchange rate pass-through given the appreciation of the naira, (2) improved food supplies following the commencement of the off-season harvest and (3) a slowdown in logistics costs. Precisely, month-on-month inflation slowed by 73bps to 2.29% in April (March: 3.02% m/m). Food inflation moderated by 112bps to 2.50% in April m/m (March: 3.62% m/m), leading to a y/y increase of 40.53% (March: 40.01% y/y). Similarly, core inflation slowed by 34bps to 2.20% m/m (March: 2.54% m/m), resulting in a y/y increase of 26.84% y/y (March: 25.90% y/y).
We expect the Committee to note the moderation in price increases, potentially citing the naira appreciation as a strong factor. However, we expect the Committee to highlight that the upside risks to inflation remain potent given the renewed pressure in the FX market and the potential review of the minimum wage, which was announced by the Federal Government to be implemented in May.
Limited FPI Inflows Mounts Fresh Pressure on the Naira
The naira halted its three-week streak of appreciation in April after the heightened war in the Middle East, particularly Iran’s retaliatory attack on Israel on April 13, triggered foreign investor flight to safe havens, thereby spurring capital outflows and mounting demand pressure in the FX market.
Furthermore, we think that concerns about the CBN’s low net FX reserves and the defence of the naira sparked risk-off sentiments amongst foreign investors and limited inflows from Foreign Portfolio Investors (FPIs). Indeed, FX inflows into the NAFEM market fell by 48.1% to USD1.95 billion in April (March: USD 3.75 billion), with inflows from foreign sources particularly led by FPIs declining by 68.9% to USD478.10 million (March: USD1.54billion). We also note that despite weak inflows from FPIs, the CBN’s intervention in various market segments has remained frail and irregular, given its weak net FX reserves. Total inflows from the CBN into the NAFEM market declined by 35.1% to USD 98.00 million (March: USD151.00 million).
Additionally, whilst the CBN maintained dollar sales to BDCs and commercial banks, the total sum of FX supplied remained insufficient to alleviate the pressure in the FX market. Consequently, the naira weakened to a low of NGN1,533.99/USD in the NAFEM market on 16 May, coming from a high of NGN1,072.74/USD on 17 April. Elsewhere, the naira fell by 34.0% to NGN1,515.00/USD as of 16 May from a low of NGN1,000.00 as of 16 April. We expect the MPC to note the depreciation of the naira in the FX market and attribute this to the renewed demand pressure from capital outflows induced by external shock. We expect the MPC to encourage the CBN to sustain its FX supply to the market to stabilize the naira while maintaining reforms to ensure reduced speculation activities and market confidence.
Central Banks Hold Rates Steady on Elevated Inflation Risks
Central Banks in advanced economies maintained steady rates in their respective monetary policy meetings. Notably, Central Banks are gaining confidence that inflation is moving in the right direction and maintained their projection of two interest rate cuts this year.
Inflation in the Euro area and the UK have maintained a downtrend as high borrowing costs continue to weigh on consumer demand and business activities. Whilst the ECB and BoE maintained interest rates at current levels at the previous meetings, the tone from their respective meetings suggested that they may be nearing interest rate cuts sooner rather than later, given that inflation maintains its deceleration path. Looking forward, we anticipate the disinflation trend to continue; thus, we expect the ECB and the BoE to begin rate cuts early in H2-24.
Unlike the Euro area and the UK, inflation has remained sticky in the US, indicating its resilient consumer spending and strong labour market, which has supported wage growth. The US Fed, however, in its meeting in May, doused concerns that it may resume interest rate hikes and maintained their projection of two interest rate cuts this year. Furthermore, the fragile economic growth (Q1-24: +1.6% vs Q4-23: +3.4%), moderation in US April inflation numbers – US inflation fell by 10bps to 3.4% in April after two consecutive months of increase – and the gloomy unemployment data points that the US monetary policy tightening is beginning to weigh on economic activities and consumer prices may begin to decline further in the coming months.
In our opinion, US inflation remains well above the US Fed target of 2.0%, which may delay future rate cuts towards the latter end of Q3-24. Additionally, we expect the US Fed to opt to hold interest rates steady till they are well convinced that inflation is brought under control. The MPC is expected to acknowledge the still-elevated interest rates in the global economy as well as the elongated war in the Middle East as potential risks to price stability.
MPC to Raise the Monetary Policy Rate by 100bps
Despite the moderation in price increases evidenced in the decline in month-on-month inflation numbers for April, we anticipate a further tightening of the monetary policy rate.
This is because (1) a one-month data release of a slowdown in prices is not sufficient for the MPC to conclude that inflation is under control, (2) inflation risks are skewed to the upside given that currency pressures have resurfaced, (3) the need to manage inflation expectations given the inflationary impact of the anticipated review of the minimum wage.
Nevertheless, we anticipate a less hawkish stance primarily due to (1) the slowdown in the pace of inflation and (2) DMO’s reluctance to take interest rates significantly higher in the fixed-income market, given its impact on the Federal Government’s debt burden. Accordingly, we anticipate the MPC to raise the MPR by 100 basis points to 25.75% while holding other parameters constant.
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