The Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) is expected to hold its third meeting of the year on the 23rd and 24th of May. As in the past meetings this year, the Committee remains faced with either maintaining its hiking cycle or keeping policy parameters unchanged. We expect the Committee to remain resolute on the path of smaller rate hikes, after taking the global and domestic events since its last policy meeting into account, more so that the CBN governor already hinted at such a path at the last policy meeting held in March. On the global scene, systemic central banks are signalling a peak in their interest rate hiking cycles although they are leaving the door open for more tightening if conditions warrant. In the domestic economy, headline inflation maintained its upward trajectory, currency pressures remain intact and there are signs the real GDP growth eased in Q1-23 primarily due to the CBN’s naira redesign drive. Overall, we expect the Committee to increase the MPR by 50bps and retain other policy parameters.

Local Economy Expected to Remain on a Growth Path, Albeit Slowly

Q1-23 was characterized by a significant cash crunch induced by the CBN’s naira redesign drive amid increased production costs. This is reflective of the impact of the policy on the informal sector, which according to the National Bureau of Statistics (NBS), constitutes 41.4% of GDP as of 2015 – World Bank estimate: 48.2% (as of 2018). Consequently, the non-oil sector’s growth is likely to have slowed significantly in Q1-23 with the agriculture, trade, real estate and arts & entertainment subsectors expected to have borne the brunt. Meanwhile, crude oil production (including condensates) averaged 1.52 mb/d in Q1-23 (Q4-22: 1.35mb/d), suggesting that the oil sector likely grew by 2.01% y/y in Q1-23, albeit not enough to lift the overall growth prospect in the review period. On a balance of factors, we forecast the domestic economy likely grew by 1.89% y/y in Q1-23, lower than the 3.52% y/y and 3.11% y/y growth recorded in Q4-22 and Q1-22, respectively.

Based on the preceding, and barring any major shocks to the economy, we forecast real GDP to grow by 2.77% y/y in 2023E (2022FY: 3.10% y/y). Overall, we expect the Committee to remain cautiously optimistic that domestic growth will stay on a growth path, albeit at a subdued pace. Hence, the Committee is likely to highlight the need to strengthen output expansion and forestall the reversal of gains recorded so far by slowing down on the pace of rate hikes and maintaining the ongoing monetary and fiscal interventions in critical growth-enhancing sectors.

Inflationary Pressures Likely to Remain Sticky in the Near Term

Consumer prices maintained their uptrend, rising by 18bps to 22.22% y/y in April (March: 22.04% y/y). We attribute the price increases to the festive-induced demand and the passthrough impact of higher transport costs in the review period. Accordingly, the breakdown provided showed that food prices rose further by 16bps to 24.61% y/y while the core inflation (+28bps to 20.14% y/y) remained at its highest level since May 2004 (23.43% y/y).

Consequently, we expect the MPC to remain concerned about the persistent inflationary pressures, likely attributing it to supply shocks and the one-off elevated demand witnessed in the review month. Overall, the Committee is likely to express further concerns on upward risks to inflationary pressures in the near term, including the prospect of subsidy removal. Nonetheless, we expect members to urge the fiscal authority to sustain its real sector interventions and take decisive steps in tackling the contributory legacy factors limiting food production and distribution in the country.

FX Supply Remain Frail Amidst Persistent Demand Pressures

Foreign investors remain on the sidelines given the lack of FX reforms, higher global interest rates and the absence of significant macro reforms. In addition, CBN’s FX supply to the different FX market segments remains significantly below pre-pandemic levels. Meanwhile, the demand for the greenback remains high as market players continue to source for FX to fulfil and clear their outstanding obligations. Consequently, the exchange rate depreciated by 0.7% to NGN465.13/USD at the official market (IEW) as of 17 May 2023 (21 March: NGN462.00/USD).

Although the decline in gross FX reserve is likely to be a source of concern at this meeting, we expect the Committee to highlight the need for the apex bank to maintain its periodic FX interventions and intensify its call to the fiscal authorities to amplify their efforts in ensuring higher crude oil production over the short-to-medium term. Accordingly, the Committee will likely reiterate that the CBN should address the pressures on the local currency by boosting the FX supply for productive activities.

Global Central Banks Appear to be Reaching the Peak of Rate Hikes

At its May policy meeting, the Federal Open Market Committee increased the target range for the federal funds rate further by 25bps to 5.00% – 5.25% (previously: 4.75% – 4.00%). However, the tone of the Committee suggests considerations of a pause in rate hikes at the next meeting, even as they left the door open for more tightening if conditions warrant. Indeed, the market is currently pricing a pause as the most likely outcome in June. Simultaneously, the European Central Bank (ECB) also slowed the pace of its monetary policy tightening, voting to increase the benchmark interest rates on the main refinancing operations, marginal lending, and deposit lending facilities by 25bps each to 3.75%, 4.00%, and 3.25%, respectively. However, the forward guidance is more of a further 25bps increase apiece in the key interest rates at its June and July policy meetings after which the ECB is likely to consider halting further interest rate increases. Elsewhere, the Bank of England (BOE) at its May policy meeting voted to increase the key policy rate further by 25bps to 4.50%, taking borrowing costs to their highest level since October 2008 (4.50%). After the meeting, the governor of the BOE stated that he hoped the BoE was now near the end of its tightening cycle, but it was too soon to be sure. Thus, we think the odds are in favour of a hike in June, with the possibility of another at the August policy meeting.

In all, the forward guidance by the systemic global central banks suggests we may be nearing the peak of monetary policy tightening. We believe a pause in interest rate increases will likely dominate H2-23. Accordingly, the aforementioned should provide some level of comfort for the MPC. Consequently, we expect the Committee to sound optimistic about the return of capital flows to emerging economies but express caution on the possibilities of global central banks keeping interest rates longer than market expectations.

MPC to Raise the Key Policy Rate Further by 50bps

Asides from the fact that global central banks are approaching the end of the interest rate hiking cycle, we think the MPC has reached a point where overtightening becomes a concern even as the debate remains on what constitutes a neutral interest rate that will not hurt domestic growth. As such, we think the dilemma for the Committee at the meeting will remain whether to (1) continue its rate hike to further dampen the rising inflation trajectory or (2) adopt a HOLD stance to observe emerging developments and allow for the impact of the last rate hikes to permeate the economy. In our view, given that the end of rate hikes by systemic global central banks is in sight amid sticky domestic inflation, we think the MPC is likely to maintain a slower rate hike at this meeting. Indeed, at the post-MPC conference in March, the CBN governor guided that maintaining an aggressive tightening poses a risk to financial system stability. Accordingly, he stated that the MPC will adopt a strategy of smaller rate hikes going forward to narrow the negative real returns amid the risks of overtightening. Consequently, we expect the Committee to increase the MPR by 50bps and retain other policy parameters.