September 27, 2022/Cordros Report

The Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) voted to raise the Monetary Policy Rate (MPR) by 150bps to 15.5% – the third consecutive rate hike in 2022. The hike brings the total rate increase so far in 2022 to 400bps, representing the largest annual increase since 2011FY (+575bps). Based on the voting pattern, ten members voted to increase the MPR by 150bps, one voted for a 100bps hike, and the final voted for a 50bps increase in the MPR. Notably, the Committee voted to increase the Cash Reserve Requirement (CRR) to a minimum of 32.5%. Aside from that, the Committee also voted to retain the asymmetric corridor around the MPR at +100bps/-700bps and the liquidity ratio at 30.0%. 
 
On domestic growth: As in the last policy meeting, the Committee expressed satisfaction with the sustained economic growth momentum in Q2-22 (3.54% y/y vs Q1-22: 3.11% y/y), which it attributes to the sustained interventions as well as credit expansion to the private sector. However, the Committee expressed concern about the contraction in the economic activities as indicated by the Composite PMI, which fell to 47.2 points in August (below the 50.0 points psychological benchmark) vs 50.4 points in July 2022. That said, the Committee expressed optimism on the economic recovery, albeit at a subdued rate in the short to medium term, given the support of the monetary and fiscal authorities in Nigeria amid the unfolding spillover effects of domestic and external shocks to the economy.
 
On Inflation: The Committee expressed concern about the unabating rise in consumer prices, as the headline inflation rose by 88bps to 20.52% y/y in June due to higher food and non-food inflation. As in the previous policy meeting and in line with our thoughts, the Committee attributed the increase in core inflation to high energy prices and a hike in electricity tariffs. Similarly, the Committee noted that the increased food prices continue to reflect broad-based insecurity, critical infrastructure deficit, sovereign risk due to election season, and the passthrough impact of exchange rate pressures. In the Committee’s view, the accelerating inflationary pressures may continue due to the lingering headwinds from the Russia-Ukraine conflict and the aftermath of the COVID-19 pandemic.

Cordros’ View
 
In anticipation of this meeting, we expressed in our publication (see report: Odds in Favour of Further Monetary Policy Rate Hike) that the Committee will raise the key policy rate by at least 50bps to maintain its fight against the high inflationary pressures, and possibly adjust the asymmetric corridor back to its pre-COVID level (+200/-500bps) from +100/-700bps around the MPR, given the continued hawkish rendition of global central banks amid a comfortable level of domestic growth and persistent inflationary pressures. Although our prognosis on the directional movement in the MPR aligned with the outcome of the meeting, the decision to raise the CRR to a minimum of 32.5% came as a surprise to us. That said, we believe the decision of the MPC was supported by the Q2-22 GDP number, which provided a cautious comfort on growth levels and provided the needed impetus for the Committee to maintain its fight against the stubbornly-high inflationary pressures, more so that a sustained negative real interest rate could dampen domestic investments and undermine the stability of the local currency. As we have previously highlighted, considering that short-term inflation expectations are biased to the upside due to (1) elevated energy prices, (2) high global food prices exacerbated by the Russia/Ukraine conflict, and (3) spending associated with the build-up of election activities, we think the action of the Committee to raise the MPR by 150bps seems justified. Moreover, the more hawkish rendition among global central banks also supports the Committee towing the same path to reduce external pressures.
 
All in, global central banks are expected to maintain their aggressive monetary tightening cycle over the rest of the year, in line with the current guidance amid sustained inflationary pressures significantly above pre-pandemic levels. On the domestic front, consumer price pressures are expected to linger while we expect domestic growth to remain intact in the near term. Accordingly, we expect the Committee to march on with its monetary policy tightening in the short term to (1) tame inflation expectations, (2) narrow the negative real interest rate gap, and (3) reduce external pressures.

Market Impact
 
Fixed Income: Since the last policy meeting, we note that investors sold off the long end of the curve, as the average yield closed higher at 12.83% on 26 September (+10bps vs 19 July: 12.73%). As stated earlier, we believe there is more room for a further interest rate hike, albeit slowly compared to the last three meetings. Based on the preceding, we advise that investors stay on the short end of the bond yield curve as it provides a duration cover against inflationary risk compared to holding long-dated bonds. Overall, we see scope for a continued uptick in FI yields as tightening global financing conditions will compel the government to increase reliance on the domestic market to finance the budget deficit.      
 
Equities: Since the last MPC meeting held in July, the All-Share Index has shed 6.0% (as of 27th September) as sensitivity to rising fixed income yields has remained elevated, despite the broadly decent earnings delivered by companies during the H1-22 earnings season. In view of the outcome of the MPC meeting, we believe the CRR hike would drag the banks’ profitability, as downward pressure on net interest margins (NIM) would inhibit earnings growth and may further limit investors’ interest in banking stocks. Additionally, we believe that the MPC’s hawkish tone would likely worsen risk-off sentiments in the local bourse as domestic investors who constitute the dominant portion of the market share (77.2% as of September 2022) may take a flight to safety amid rising FI yields. Overall, we expect the local bourse to maintain cautious trading sentiments as electioneering activities kick off in full gear.