January 27, 2021/Cordros Report
After its first meetings of the year, the Monetary Policy Committee (MPC) voted unanimously to keep all the policy parameters unchanged at today’s meeting. The move was in line with our expectation with no material changes to the Committee’s November narrative. Like in the November meeting, the Committee highlighted the need to adopt an accommodative monetary policy stance to support economic recovery.
On domestic growth: In line with our expectation, the Committee expressed concerns about the decline in the Manufacturing and Non-Manufacturing PMI in December which they attributed to the resurgence in COVID-19 cases, foreign exchange pressure, increased cost of production, and the general decline in economic activities. We also highlight that the Committee shifted its expectation for positive output growth to Q1-21 and stated that growth will be supported by the coordinated and sustained interventions of both the monetary and fiscal authorities including the broad-based liquidity injections. Again, in line with our expectation, the Committee urged the apex bank to sustain the use of heterodox policies such as the CRR debits, Loan-to-Deposit ratio (LDR) policy, and direct interventions in the agriculture and manufacturing sectors to support output growth.
On inflation: Similar to its November narrative, the Committee reiterated its concern that supply-side factors remain the predominant drivers behind the surge in inflation. It, however, did not rule out the effects of monetary factors on domestic prices following the growth in broad money supply by 11.0% in December 2020 (November 2020: 5.0%). It further highlighted that persistent security challenges across the country, as well as lingering infrastructural deficiencies that continue to impact the movement of food items from the rural to the urban areas, amplified the upward pressure on domestic prices. Other factors highlighted include the deregulation of the downstream oil sector and the hike in electricity tariffs. The Committee expects the inflationary pressure to begin to moderate in the near term as the domestic negative output gap closes.
On foreign exchange: The Committee noted the accretion in external reserves was attributable to the uptick in crude oil prices and improvement in global economic activities. The Committee further expressed optimism on its new policies on diaspora remittances, and non-oil export promotion to continue to drive accretion in the external reserves. Although the Committee was of the view that further accommodative monetary policy is needed to jump-start the recovery process, it was quick to point out that it would give rise to a liquidity surfeit that will worsen exchange rate pressures.
Cordros’ View
The Committee’s decision to HOLD rates reinforces the fact that its current priority is to support economic recovery. However, we note that the Committee struck a more dovish tone than we expected, suggesting that monetary policy will remain broadly accommodative in the near term. In our view, the second wave of the pandemic, at a time when the economy is still in a recession, was the key driver behind the dovish theme that characterised the outcome of the meeting. Notably, the Committee expressed its view that the government should step up efforts in combating the pandemic without mulling another lockdown, citing that it would unwind gains associated with the fiscal and monetary stimulus rolled out since the onset of the pandemic.
On growth, we still expect a marginal decline in economic activities in Q1-21 with the low base from Q2-20 translating to improved growth in Q2-21 – a U-shaped recovery. On inflation, the pressure on domestic prices will persist over the medium term and reach a peak of 18.19% y/y at the end of Q2-20. Consequently, we expect inflation to moderate at the beginning of Q3-20, predominantly on the high base from the corresponding period of 2020.
We expect the Committee’s continued lack of clear-cut guidance on the large spread between the parallel market and NAFEX exchange rates to continue to dampen activities in the manufacturing sector. With foreign investors on the side-lines and the impact of the diaspora remittances policy on dollar inflows likely to be limited, we expect the imbalance in the external sector to persist amidst a sustained increase in the demand for foreign exchange.
Market Impact
Fixed Income: In recent week’s bond investors have exhibited aversion for long-duration bonds, a development that has made short–term bonds defensive amid robust system liquidity. This has culminated in the steepening of the NGN yield curve, as investors have demanded higher yields to improve inflation-adjusted returns amid expectations of increased supply from the DMO. With the decision of the Committee aligning with market expectations and the somewhat dovish tone struck by the CBN Governor, we expect risk appetite for mid to long-dated bonds to improve marginally, putting the brakes on further steepening in the yield curve. Our view is further underscored by the January 2021 bond auction where the DMO relied more on non-competitive bids as it sold less than it offered to the market.
Equities: Pre-meeting, we observed that the upward repricing of yields on long-dated bonds triggered reduced appetite for equities among domestic institutional investors. With the MPC maintaining the “lower-for-longer” theme for rates, we expect a positive reaction in the equities market. Accordingly, we expect risk-averse investors to recalibrate their portfolio towards fundamentally sound stocks with attractive dividend yields. With the eagerly anticipated MPC meeting out of the way, we now expect investors’ attention to be focused on bond auction results as they seek clues on the direction of yields in the FI market.
