Post-MPC Reaction: Monetary Policy Rate Cut -Moving Back to Convention?

At the end of the second meeting of the Monetary Policy Committee (MPC) of the Central Bank of Nigeria, which was concluded today, 26th March 2019, the Committee decided, in perhaps the last MPC communique of Governor Godwin Emefiele, on a vote of 6 to 5 to reduce policy rate by 50bps (13.5%) after having held the rate at 14.0% since July 2016. The Committee in an unexpected twist, cited the need to shift policy focus to supporting growth amongst other considerations. In our earlier Pre-MPC report, we noted that “we expected the MPC to hold all policy rates at current levels in next week’s meeting, although the case for monetary easing has become compelling”. However, our expectations were off as the Committee favoured a rate reduction.

Our Perspective of the Decision
Since the July 2016 tweak in MPR and the subsequent use of short-term market rates to anchor monetary policy, we have continuously expressed our views on the redundancy of the benchmark rate. We think the MPC is moving back to convention and aligning policy rate to market rates. Currently, the average short-term discount rate settled at 12.7% (implying an average yield of 13.6%), which aligns with the new MPR at 13.5%. We are not distracted to believe an easing cycle has begun; rather, we think policy stance remains intact considering global interest rate development and the desperation to sustain and retain flows. The CBN can always resort to OMO to achieve the objective of attracting and retaining capital flows.  In addition, credit to private sector is not expected to improve on the back of rate reduction as structural bottlenecks and the elevated business risk environment remain drags to credit creation. Price pressures, on the other hand, should also not deteriorate as it has been consistently proven that Nigeria’s inflation is largely cost push.

Implications for Market Trading
Although the decision of the 123rd MPC meeting was not anticipated by the market, the magnitude of rate cut should result in a muted impact on yields. Already, short term rates are trending downwards post elections as foreign flows continue to be attracted to local high yielding instruments. Evidently, foreign capital inflows must be sustained from the CBN’s perspective and barring any short-term shock in the oil market, market conditions would have forced short-term and long-term yields (at least) 200bps lower even if MPR was retained at 14.0%.

  • Fixed Income Market Trading: We expect the initial reaction to be a soft moderation in average bond yields, at least 50bps to 100bps, but long-term expectation should see up to 200bps yield decline from current levels. Fund managers trading above 5-year term to maturity on the yield curve would benefit the most. The short-term fixed income market (OMO and T-Bills) may also experience slow activities in the short-term as we expect possible further drop in discount rate (at least 50bps).
  • Equities Market Trading: Sentiment remains fundamentally weak in the equities market; this is not anticipated to change in the immediate on rate cut. The gradual recovery in the economy is slow paced and may not support an overtly bullish earnings expectation in the short-term. Yet, we believe the market has been far compressed and remains attractive for equity investors. Post-2019 Presidential election conclusion, market has lost on 16 of 22 days so far traded. Current market valuation (7.9x) relative to Egypt (16.6x), Kenya (11.3x), Ghana (22.9x) and South Africa (17.0x) shows clear undervaluation; we are convinced the next phase is a bull run.