Decision Preview September 17, 2010

 

The Monetary Policy Committee (MPC) will hold its next meeting on September 21, 2010 to review the domestic economy in line with global economic developments and reassess its monetary policy stance in a bid to balance the upside risk to price stability and downside risk to economic growth. We expect the Monetary Policy Rate (MPR), Liquidity Ratio (LR) and Cash Reserve Ratio (CRR) to remain unchanged at 6%, 25%, and 1% respectively.

 

 

Recent data from the National Bureau of Statistics (NBS) indicate that inflation continued to drift towards acceptable levels, though risk to its stability over the short term remains high. This is due to the planned removal of petroleum subsidies with its cost-push inflationary pressures, anticipated monetary growth from the purchase of toxic assets by AMCON, increased government spending, as well as inflows to rescued banks.

 

 

However, with the AMCON yet to commence operations coupled with the ongoing uncertainty surrounding the recapitalization of rescued banks, the threat to inflation from expected rise in money supply is reduced amid continuing underperformance of monetary aggregates, relatively stable exchange rate and adequate food supply. Inflation rate ebbed to rebased values of 13% year-on-year in July 2010 from 14.1% in June. .2010

 

 

 

With GDP growth for Q3 2010 estimated at 7.76%, up from 7.45% and 7.69% recorded in Q1 and Q2 2010, respectively, the binding constraints on the domestic economy remain: poor infrastructure, lack of access to finance and poor investment climate, which calls for sustained pursuit of macroeconomic, structural and institutional reforms to revamp the economy; or at the minimum, maintain present policy stance.

 

 

The option to cut or raise MPR is open to the CBN based on its overriding objective of achieving non-inflationary growth. An increase in MPR is not expected as CBN would rather tighten money supply to curb inflation through the issuance of government securities. On the other hand, a cut in the benchmark interest rate has a short-run positive effect on economic growth but with long-run inflationary risk. Lower interest rate leads to higher investment and economic activity, which in turn stimulates spending (by both businesses and households) and could lead to a rise in the general price level.

 

 

At the MPC meeting of May 10, 2010, the Committee noted the risk of a higher inflation, asset bubble, continued fall in external reserves and pressure on exchange rate. A sudden variation in the policy rate would likely distort stability of the financial sector. Hence, the Committee may decide to keep its key rate unchanged at 6%, until broad-based macroeconomic stability is achieved. Also, it will likely maintain the asymmetric corridor of interest rates: Standing Lending Rate (SLR) and Standing Deposit Rate (SDR) at 8% and 1%, respectively.

 

 

The critical challenge for the Committee would be to ensure that credit flows to the real sector is accelerated. CBN is unlikely to deviate from its commitment to maintain a low cost of fund regime, as well as ensure stability in exchange rate, interest rate and inflation rate. The recent reforms and cash injection – Power Sector Fund, SME Fund and Agric Fund – buttress CBN’s commitment to stimulate growth.

 

 

Given indications that inflation may be problematic over the short to medium term, we believe that the MPC would address the cost-push pressures driving inflation through adjustment in monetary aggregates and keep MPR at its current level of 6%. All other rates are also likely to remain at current levels. We expect that the CBN would continue to guarantee interbank transactions.

 

 

Source: Access Bank