The Monetary Policy Committee (MPC) has slated its second meeting of the year for 25th and 26th of March, deviating from its usual schedule (MPC typically convenes bi-monthly). The meeting follows on from the February meeting when the Committee implemented a 400 basis points hike of the monetary policy rate. Although the full impact of the interest rate hike on domestic prices may not be apparent yet, recent inflation data (February: 31.70%) indicates that inflation risks remain prominent. Therefore, we believe the MPC will maintain a tight monetary policy stance to (1) further tighten monetary conditions, (2) reduce the negative real interest rates and (3) anchor inflation expectations. Consequently, we anticipate a 200 basis points hike in the MPR while holding other parameters constant.
GDP Expected to Grow at a Slower Pace in Q1-24
Tracking the recent events and economic data released in the quarter, we highlight that the economy remains resilient despite the heightened inflationary pressures and the paucity of foreign exchange. This was indicated in the Composite PMI data for January (54.5 points) and February (51.1 points), which remained above the 50-point expansionary threshold but declined. However, the lower PMI figure in February highlights industries grappling with high production costs, naira depreciation and waning consumer demand. Nevertheless, we expect the Composite PMI to remain above the 50-point threshold in March supported by improved forex liquidity and festivities (Ramadan activities and Easter Celebrations).
On the other hand, domestic crude oil production (including condensates) fell to 1.54mb/d in February (January: 1.64mb/d). However, we project oil production to average 1.57mb/d in Q1-24, 2.60% higher than the average of 1.53mb/d in Q4-23. Considering these factors, we estimate a growth rate of 2.30% in Q1-24, which is a slowdown from Q4-23 GDP growth rate of 3.46%. Consequently, we expect the Committee to recognize the trade-off between the policy objective of output growth and price stability. However, drawing from the previous meeting, we highlight that the Committee acknowledges the implications of high inflationary pressures on growth, thus supporting its decision to maintain high interest rates to curb inflation. The MPC pointed out that a stable economic growth rate is unachievable in a high inflationary environment.
Domestic Prices Maintained Upward Trend in February
Consumer prices have remained elevated in 2024FY, with headline inflation rising by 180bps and reaching a 25-year high of 31.70% in February (January: 29.90%). We attribute the heightened inflationary pressures primarily to the troika impact of (1) naira depreciation, (2) lower food supplies due to harvest depletion and increased smuggling activities, and (3) higher energy prices. Food inflation rose faster by 271bps to 37.92% (January: +35.41%), while core inflation rose by 154bps to 25.13% (January: +23.59%). On a month-on-month basis, headline inflation ticked higher by 48bps to 3.12% (January: 2.64%). We expect the MPC to highlight the persistent increase in price pressures due to the exchange rate pass-through, spike in energy costs, large fiscal deficit, and heightened insecurity in the food-producing region. Given the existing upside risks to inflation, the Committee will expect inflation to remain high in the short to medium term.
CBN’s Policy Interventions Stabilise Naira in the Forex Market
Following the latest MPC meeting in February, the CBN forged ahead with its actions in the FX market while increasing its intervention to stabilize the naira. These include (1) an increase in yields on naira-denominated assets to attract both domestic and international investors and curb currency speculation, (2) addressing FX backlogs – the CBN successfully cleared all valid foreign exchange backlogs, which was estimated at USD4.60 billion (USD2.40 billion out of the USD7.00 billion was declared invalid) on the 20th of March, (3) the incorporation of BDCs into the CBN’s foreign exchange framework – CBN re-commenced the sale of US dollars to the BDCs on February 27, and (4) retail sale of dollars to banks with the range of NGN1,300/USD – NGN1,400/USD. Notably, the naira appreciated to a high of NGN1,453.00/USD in the NAFEM market on the 21st of March from a closing rate of NGN1,560.57/USD on the 19th of March as liquidity improved.
We highlight that the recent overhaul and increased intervention in the FX market have bolstered confidence and facilitated Foreign Portfolio Investors (FPIs) inflows into the forex market. We note the renewed interest from foreign portfolio investors in the fixed-income market as stop rates on the long-end bills rose above 20.0%. Indeed, the FX reserves recorded a 4.16% gain, coming in at an 8-month high of USD34.38 billion year-to-date, primarily due to increased inflows from FPIs and higher remittances – the CBN noted remittances of USD1.30 billion in February. We anticipate the MPC will acknowledge the stability of the naira in the forex market over the past few weeks, attributing it to recent reforms and improved forex liquidity. We expect the Committee to commend the CBN for the successful settlement of the FX backlog while also echoing the need for the apex bank to maintain its reforms and its intervention in the FX market to sustain the stability of the naira.
Central Banks Continue to Hold Rates Steady on Sticky Inflation
Once again, central banks in advanced economies opted to maintain policy rates at stable levels at their respective March meetings, signaling no immediate plans for rate cuts. These decisions were influenced by the existing inflation risks, including tight labour markets and high commodity prices induced by increasing geopolitical tensions. Moreover, inflation rates across most developed markets remained above target levels.
During its recent meeting, the US Federal Reserve voted to maintain the target range for the federal funds rate at 5.25% – 5.50% while maintaining its projection of three interest rate cuts for 2024. The Fed indicated that the timing of these cuts would depend on further evidence of inflation moving towards its target. However, we believe that robust GDP growth and a strong labour market in the US could keep inflation sticky, potentially delaying rate cuts until H2-24.
Similarly, the European Central Bank (ECB) chose to leave its three benchmark interest rates unchanged at 4.50%, 4.75% and 4.00% earlier in the month. The ECB expressed optimism that inflation would continue to decline throughout the year, supported by lower energy prices. However, the ECB reiterated its commitment to lowering inflation to its 2.0% target, which supports its decision to maintain higher interest rates. We anticipate that inflation in the Eurozone will continue its downward trajectory, potentially setting the stage for a rate cut at the ECB’s June meeting.
In line with these developments, the Bank of England (BoE) decided to keep its policy rate steady at 5.25% following a decrease in inflation in February (3.40% compared to January’s 4.00%). We believe that the sluggish economic activity in the UK, coupled with high borrowing costs, has contributed to the slowdown in price increases. If energy prices remain low, inflation could continue to decrease in the coming months, potentially paving the way for a rate cut by the BoE in May. We envisage the MPC identifying the prevailing global risks, which include high commodity prices induced by the heightened geopolitical tensions and the potential for Central Banks to keep interest rates higher for a longer period of time.
MPC to Raise Policy Rate by 200bps
We highlight that the MPC’s tone from the last meeting indicates the Committee’s intolerance for further price increases and its commitment to ensuring inflation is brought down towards the target level. The Committee noted the significant pass-through effect of the exchange rate on domestic prices and emphasized the imperative for exchange rate stability as one of its means of reducing inflationary pressures.
Whilst the current measures implemented by the Committee and CBN are beginning to yield results (reduced naira volatility and improved FPI inflows), the impact on domestic prices is yet to materialize as prices remain elevated. We attribute this to a lag effect (the time it takes for an action to yield desirable results) and other inflation-stoking factors that are directly beyond the control of the MPC, including (1) heightened insecurity in the food-producing middle-belt region, (2) increased smuggling of food across the border, and (3) large fiscal deficit. Notwithstanding, we highlight that the need to (1) anchor inflation expectations, (2) further tighten monetary conditions, and (3) support continuous FPI inflows will underpin the Committee’s decision to maintain a tight monetary policy stance. Accordingly, we expect the MPC to raise its policy rate again by 200bps, pushing it up to 24.75% while holding other parameters constant.
Cordros
