Pre MPC: Status Quo to be maintained on Downside Risks of Capital Flow Reversals

The Monetary Policy Committee (MPC) is set to have its 2nd meeting for the year on the 21st and 22nd of May, 2018 and as with all meetings since July 2016, we expect the committee to maintain status quo on all policy rates. We expect emphasis to be placed on the need to withstand a possible pass through inflation from rising global inflation as well as protect the economy and financial markets against rising downside risk of capital flow reversals. Below are our thoughts on possible MPC considerations.

Favorable Global Economic Conditions amidst Downside Risk of Capital Flow Reversals
Developments in the global economy and financial markets are likely to be viewed with mixed feelings by the MPC next week. On one hand, favorable economic data in the US (US retail sales reports and Consumer Price Index data) have strengthened markets’ conviction of further rate hikes by the US Fed, resulting in an upward repricing of US bond yields to record highs while the US Dollar has risen. Much like the “taper tantrum” of 2013 which led to a rout in asset prices across emerging markets, the feedback effect of rising bond yields and strengthening US Dollar was felt in emerging and frontier markets in the last three weeks as LCY (local currency) fixed income instruments were sold off while currencies came under pressure. As a result, the JP Morgan EM bond index is down 2.3% in May while the MSCI EM Currency index has lost 3.1% since peaking in April.

However, much to the delight of policymakers in commodity exporting countries, oil prices hit US$80.0/b mark during the week - its highest since June 2014 – against the backdrop of the US exit from Iran’s nuclear deal as well as falling inventory levels and subsisting impact of OPEC’s production cut deal. Higher commodity prices is a boon to Nigeria’s external sector stability and fiscal balance, but it also comes with attendant risk of ballooning State’s petrol subsidy. On a balance of risks, we believe that external sector developments remain broadly favorable for Nigeria, supportive for economic growth and current monetary policy stance. Yet, the MPC will likely maintain its cautious view due to emerging downside risk of capital flow reversals.

Data Releases have Mirrored Positive Outlook for Domestic Growth and Dis-inflation
In the domestic landscape, economic data releases since the last MPC meeting have mirrored current positive outlook for the economy. The Purchasing Managers Index (PMI) released for April indicated an expansion in the economy (Manufacturing PMI stands at 56.9 while Non-Manufacturing PMI at 57.9) while dis-inflation trend extended to the 15th consecutive month in April. FX rate has already remained stable in all segments while External Reserves have stabilized around the US$47.5bn mark. On the same day the MPC is starting, the NBS is due to release Q1:2018 GDP numbers, which we expect to show continued expansion (Afrinvest Research projection: 2.6%) driven by low-base effect of Oil sector GDP as well as rebound in Trade and ICT. Sub-3.0% is however still substantially below long-term trend and potential, implying further policy accommodation and structural reforms will be required to reduce the output gap.

MPC to Maintain Status Quo in View of Volatility in Emerging Markets Currencies
As we mentioned in our April Headline Inflation reaction on Tuesday, we think the positive development in consumer prices within the last 14 months has presented the CBN with an opportunity to begin to converge Monetary Policy Rate (MPR) with market interest rates which have since priced-in inflation expectation. However, we think the decision will be delayed due to the ongoing capital flow reversal and asset prices volatility in emerging and frontier markets which is a downside risk to what has come to be the CBN’s prime policy anchor – Exchange Rate stability. The current capital flow reversal has been the strongest test for liquidity in the Investors’ and Exporters’ Window (I&E Window) so far; a test it is yet to pass with flying colors. The CBN has responded to the volatility in the Fixed Income market and increased demand for FX by tightening liquidity in the money market in the past two week.

We believe the odds of the MPC slashing the MPR in the same period it is aggressively sterilizing liquidity is slim; hence we expect the CBN to maintain status quo on all rates. Regardless, as we have argued in previous notes, an MPR cut (either at next week’s sitting or subsequent ones) will have little impact on fixed income yields as the CBN has already set in motion the easing cycle by deliberately guiding market rates downwards in the last 3 quarters, in addition to knock-on effects of the FGN fiscal strategy to reduce domestic debt issuance.