TUE, 24 MAY, 2022-theGBJournal| In what can be regarded as a shocking event, the Monetary Policy Committee (MPC) voted to increase the MPR to 13.0% at its recently concluded meeting, the first rate hike since July 2016.
In terms of voting pattern, six members voted to increase the MPR by 150bps, four voted for a 100bps hike, and one voted for a 50bps increase in the MPR. The Committee also voted to retain the Cash Reserve Requirement (CRR) at 27.5%, liquidity ratio at 30.0% and asymmetric corridor around the MPR at +100bps/-700bps.
According to the Central bank Governor, the Committee decided to hike interest rates after careful consideration of the need to strike a delicate balance between containing inflationary pressures whilst supporting economic recovery and mitigating capital flow reversals associated with global central banks’ normalisation of monetary policy.
On domestic growth: The Committee highlighted the sustained economic growth momentum in Q1-22 (3.11% y/y VS Q4-21: 3.98% y/y) and attributed it to the spillover effect of continued policy support on aggregate consumption expenditure. Farther out, the Committee expects output growth to continue, albeit at a much-subdued pace, given the unfolding pass-through impact of domestic and external shocks on the economy. Accordingly, the Committee expects the economy to grow by 3.24% in 2022E, in line with the CBN’s estimates which is slightly below our revised projection (3.51% y/y).
On Inflation: The Committee expressed concerns about the domestic inflationary pressures, which increased for the third consecutive month in April (16.82% y/y vs March: 15.92% y/y), given price increases across the food (+117bps to 18.37% y/y) and core (+26bps to 14.18% y/y) inflation sub-baskets. In line with our thoughts, the Committee attributed the increase in the core inflation to high energy prices and a progressive hike in electricity tariffs. Similarly, the Committee noted that the increased food prices continue to reflect legacy structural constraints and security challenges in the food-producing regions. Overall, the Committee expects that consumer prices will remain elevated, particularly given the spending associated with the build-up of election activities.
Cordros’ View
Before this meeting, we expressed in our publication (see report: MPC May Raise MPR to Stabilise the External Sector) that the “reactive function” of the Committee will be significantly challenged at this meeting, given the evolution of events across the domestic and international scenes.
Although our prognosis on the directional movement in the MPR aligned with the outcome of the meeting, the magnitude of increase in MPR (150bps vs Cordros’ estimate of 50bps) came as a surprise to us. That said, we believe the decision of the MPC must have been induced by the realisation that the sharp increase in the headline inflation in April (+90bps to 16.82% y/y) is a strong pointer that price pressures have become entrenched in the economy. As a result, we believe the Committee felt proactive measures are required expediently to nullify the indirect channels through which accommodative monetary policy amplifies inflationary pressures.
Moreover, 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. Furthermore, we imagine that the impressive Q1-22 GDP print of 3.11%, the sixth consecutive quarter of positive growth, also brought some comfort to the Committee that the economy is strong enough to withstand a 150bps increase in the MPR, as opposed to a progressive hike of 50bps over the next three meetings.
In addition, we think the hawkish rendition among global central banks further compelled the MPC to make a U-turn on its pro-growth objective to mitigate capital flow reversals and stem currency pressures.
It is imperative to note that the decision of the MPC is in line with the actions of Central banks on the continent. For context, the Bank of Ghana (BOG) voted to increase the Monetary Policy Rate (MPR) by 200bps to 19.00% at its May policy meeting.
Similarly, the Monetary Policy Committee of the South African Reserve Bank (SARB) raised the repo rate by 50bps to 4.75% at its May meeting, while the Central Bank of Egypt recently raised the deposit and lending rate by 200bps apiece to 11.25% and 10.25% respectively. On the global front, the story is not different as the US Federal Reserve has raised the federal funds rate by a cumulative of 75bps. At the same time, the Bank of England increased interest rates for the fourth consecutive time at its recently concluded meeting (5th May) by 0.25% to 1.0%. The common reason adduced by these central banks is the need to fight inflationary pressures and tighten the screws on easy money. With global central banks expected to sustain rate hikes over the course of 2022, we think the fundamental question is, “will the MPC raise interest rates aggressively to keep pace with the hiking cycles?”.
In our opinion, the MPC has opted for a proactive stance by frontloading rate hikes at this meeting instead of a gradual increase in the MPR. We believe concerns about the domestic economy’s health and the need to ease the burden on government financing costs will make the Committee hold off on further rate hikes in the next two meetings in July and September. However, we have pencilled down a 100bps hike in the MPR at the last meeting in November. In the interim, we expect the CBN to sustain the use of its development finance initiatives to ensure the rate hike does not derail the fragile recovery.
Market Impact
Fixed Income: Before this meeting, the market was already bracing up for an upward retracement in yields as fixed-income investors exhibited aversion for long-dated instruments. Since the last policy meeting in March, we note that the yield on the Mar 2050 instrument has repriced higher from 12.85% (31st March) to 13.0% as of 23rd May. We believe the outcome of this meeting will trigger another round of selling activities on the long end of the yield curve. We thus reiterate our view that investors should remain wary about duration risk given our expectations of a tight monetary posture from the CBN, as evidenced at this meeting. 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 borrowings.
Equities: With the surprise 150bps hike in the MPR orchestrated by the MPC, we expect negative sentiments to dominate market performance in the short term. Indeed, the stock market shed 1.82% at the close of the market today, the most significant single-day loss since 1st Dec 2021 (-1.81%). We think this was triggered by a knee-jerk reaction from investors, given that rising FI yields typically make equities less attractive.
Moreover, 2022 being a pre-election year further suggests that investors would minimise exposure to risk assets. Nonetheless, we do not envisage a prolonged bearish run in the market, given the strong corporate earnings delivered by companies in the Q1-22 earnings season. As such, we think a short-term market correction will present opportunities for investors to make re-entry into stocks with sound fundamentals and attractive dividend yields.
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