The Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) is expected to hold its fourth meeting of the year on the 24th and 25th of July. Following the suspension of Godwin Emefiele, the meeting will be chaired by the CBN’s acting Governor, Folashodun Shonubi. Thus, we think the focus at this meeting will be setting a new tone for monetary policy direction over the next few months, in line with the monetary policy and FX reforms since 29 May. Nonetheless, like previous meetings, we expect the Committee to consider developments in the global and domestic economy since the last policy meeting. On the global scene, systemic central banks are signalling a peak in their interest rate hiking cycles. However, they are leaving the door open for an additional smaller rate hike in the near term. In the domestic economy, headline inflation maintained its upward trajectory, currency pressures remain intact, and there are signs that real GDP growth settled higher in Q2-23 after the cash crunch-induced moderation in Q1-23. Overall, while our baseline view is for the MPC to adopt a HOLD stance at this meeting, we do not rule out a 25bps – 50bps hike in the MPR while retaining other policy parameters.

Domestic Economic Activities Likely Impressed in Q2-23 Relative to Q1-23

The domestic economy appears to have shrugged off the impact of the cash scarcity witnessed in Q1-23 after the Supreme Court on 3 March ordered that old high-denominated notes remain in circulation until the end of 2023. Nonetheless, Q2-23 was majorly characterised by PMS subsidy removal and fiscal and monetary policy reforms, with the likely impact of moderating household consumption in the near term. Overall, we imagine that the non-oil sector’s growth improved in Q2-23 relative to Q1-23 as the cash crunch’s impact subside. Meanwhile, crude oil production (including condensates) averaged 1.38mb/d in Q2-23 – 8.9% lower than the 1.52mb/d average in Q1-23 – primarily due to the strike action-induced production slowdown in April. Based on the preceding, we envisage that the oil sector likely contracted further in Q2-23, albeit lower than the decline in Q1-23. On a balance of factors, we forecast the domestic economy to have grown by 3.11% y/y in Q2-23, higher than the 2.31% y/y growth recorded in Q1-23 but lower than 3.54% growth in Q2-22.

Based on the preceding, and barring any significant economic shocks, we forecast real GDP to grow by 2.92% 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 will likely highlight the need to strengthen output expansion and forestall the reversal of gains recorded so far by slowing down on the rate hikes and maintaining the ongoing monetary and fiscal interventions in critical growth-enhancing sectors.

Consumer Prices Biased to the Upside in the Short Term

Although the pace of consumer price increases defied market expectations in June, we highlight that the headline inflation still increased to a new 18-year high, rising by 38bps to 22.79% y/y in June (May: 22.41% y/y). The breakdown showed that food prices increased by 43bps to 25.25% y/y, while the core inflation advanced by 22bps to 20.27% y/y.

Given that consumer price pressures are still biased to the upside as we are yet to fully see the impact of FX and subsidy reforms on prices, we expect the Committee 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. Elsewhere, the MPC is likely to express medium-term optimism on prices decelerating after the full impact of lingering reforms permeates into the general price level.

FX Volatility Increased Despite the CBN’s FX Liberalisation

The major currency highlight since the last policy meeting in May was the CBN abolishing its multiple FX windows and collapsing all its various FX rates into the Investors and Exporters Window (IEW) on 14 June. Accordingly, the gap between the parallel market and official exchange rate has narrowed significantly, with the naira depreciating significantly by 37.9% year-to-date (as of 18 July) to NGN742.93/USD at the Investors and Exporters Window (IEW). However, we understand that foreign investors have remained on the sidelines, awaiting signals from the CBN to clear the existing FX backlogs and possibly push market interest rates higher. Consequently, FX demand continues to outstrip supply, with most of the flows trickling into the market from local corporates against foreign investors. Nonetheless, we note that the CBN has consistently sold FX at the IEW, albeit at small volumes, every week starting from 22 June since its FX liberalisation. The total FX supplied through this means settled at c. USD96.00 million as of the week ending 14 July.

We expect the Committee to reiterate the need for the CBN to build up the FX reserves while maintaining its periodic FX interventions to limit volatility in the IEW. At the same time, the Committee may intensify its call to the fiscal authorities to amplify their efforts in ensuring higher crude oil production over the short-to-medium term.

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

At its June policy meeting, the Federal Open Market Committee (FOMC) voted to maintain the target range for the federal funds rate at 5.00% – 5.25%, stating that it allows the Committee to assess additional information and its implications for monetary policy. However, despite the diminishing consumer price pressures (3.0% y/y in June vs May: 4.0%), we highlight that the core inflation (4.8% y/y as of June) remains above the headline reading, implying that broad inflationary pressures remain intact. In addition to the resilient labour market conditions, the preceding bolster arguments for additional rate hikes. Indeed, the market is currently pricing a 97.3% chance of a 25bps hike when the Fed meets on 26 July. When the European Central Bank (ECB) raised its key policy rates further by 25bps in June, the Governing Council highlighted that its future decisions would ensure that the key interest rates would be brought to sufficiently restrictive levels to achieve a timely return of inflation to the 2.0% medium-term target and will be kept at those levels as long as necessary. Thus, we anticipate the ECB will likely increase the key policy rates further at its next meeting before embarking on a HOLD stance at subsequent meetings. Elsewhere, the Bank of England (BoE), at its June policy meeting, voted to increase the key policy rate further by 50bps to 5.00%, higher than market expectations of a 25bps hike. In influencing its decision of a more prominent rate increase, the Committee stated that there had been a significant upside in recent data indicating more persistence in the inflation process. Looking ahead, we understand that gilt yields have risen materially, particularly at shorter maturities, now suggesting a path for a bank rate average of 5.50%.

The global interest rate path suggests a synchronous slower rate hike when key international central banks meet in July, after which adopting a “HOLD” stance will likely dominate subsequent meetings in 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 Likely to Retain the MPR but with a Hawkish Tone

Asides from global central banks approaching the end of the interest rate hiking cycle, we think the MPC has reached a point where overtightening becomes a concern as the economy is already battling with the negative impact of elevated interest rates. 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. However, at this stage, continuous increases in the MPR at a time when non-monetary factors are the dominant upside risk to near-term price pressures will undermine economic growth. On a balance of factors, while our baseline view is for the MPC to adopt a HOLD stance at this meeting, we do not rule out a 25bps – 50bps hike in the MPR while retaining other policy parameters.

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