Debt Market Investors Advised to Position for Upward Interest Rate Repricing
Patience Oniha, Director General, Debt Management Office

Debt Market Investors Advised to Position for Upward Interest Rate Repricing

Following the decision of the Monetary Policy Committee (MPC) to hold benchmark interest rate, analysts have advised debt market investors to position their portfolios towards a possible upward repricing of interest rates in the second quarter (Q2) of 2021.

Analysts at Chapel Hill Denham in a note explained that the Central Bank of Nigeria’s (CBN) dovish interest rate policy has led to unprecedented low yields in the fixed income market, despite galloping inflation.

Short-term rates have fallen to zero while bond yields have collapsed by 700 basis points year to date to an average of 4.2%, the firm said.

However, analysts stated that the CBN appears convinced that inflationary pressures are solely supply-side driven.

Although, anecdotal evidences point to other factors such as weak exchange rate liquidity and credit impulse.

“As a result, we do not expect any changes in the CBN’s interest rate policy, until the economy returns to growth in Q2-2021”, Chapel Hill Denham said.

It then added that at that point, the firm expects the CBN’s pro-growth stance to take the back seat in favour of its primary mandates of price and exchange rate stability.

Analysts added that timing of the exit from recession also coincides with a period that interbank liquidity will likely come under pressure as maturity of OMO bills declines substantially from April 2021.

In line with analysts’ expectations, the MPC maintained status quo on all policy rates at the end of the 2-day MPC meeting which ended yesterday, 24th November 2020.

The Committee voted unanimously to retain the benchmark Monetary Policy Rate (MPR) at 11.50%, and the asymmetric corridor around the MPR at +100bps/-700bps.

Cash Reserve Requirement (CRR) at 27.5%, and liquidity ratio at 30.0% were not adjusted.

Outlook and Key considerations of the MPC

At the meeting, key considerations of the MPC include weak gross domestic product (GDP) growth backdrop, indicated by the -3.62% Q3-2020 GDP print, and thus confirmed the economy is in a recession.

However, the Committee noted that contraction had bottomed out and expects the economy to recover from recession in Q4-2020, based on knock-on impacts of monetary and fiscal expansion.

MPC also considered upward pressure on domestic prices due to COVID-19 pandemic and other legacy factors.

This include the prevalence of security challenges, increase in food prices, recent hike in the pump price of PMS and electricity tariff.

It noted the increase in credit to key sectors and encouraged further expansion in credit to employment-generating sectors.

Meanwhile, macroeconomic data showed that Broad money supply rose marginally to 3.52% in October from 3.20% in September 2020.

Aggregate domestic credit grew by 7.61% in October from 7.35% in September.

It was noted that banking credit stood at N19.54 trillion on 13th November, up by N3.97 trillion since the Loan-to-Deposit (LDR) policy was introduced in May 2019.

The Committee noted recent impressive performance recorded in the equities market, particularly the increased patronage of local investors, driven by low fixed income yields.

It then considered improving financial soundness indicators as NPL ratio declined to 5.75% in October from 6.1% in August 2020.

Read More: MPC: Softening Global Interest Rate Favours Policy Rate Cut -NOVA

Expressing opinion, analysts at Chapel Hill Denham stated that as expected, the MPC struck a neutral tone in its communique, given competing goals of price stability and economic growth.

“On one hand, inflationary pressures have increased consistently over the past 14 months, due to structural challenges, supply chain disruptions and weak liquidity in the foreign exchange markets.

“Headline inflation rate rose for the 14th consecutive month in October, surging by 53bps to a 32-month high of 14.23% year on year from 13.71% in September.

“Inflation expectation remains elevated against the backdrop of energy price shocks, weak harvest and FX rate depreciation”, analysts explained.

On the other hand, the firm stated that the economic activities are still reeling from the COVID-19 induced disruptions and the oil price shock.

The MPC noted that tightening could stall the economic recovery, while loosening could exacerbate the inflationary pressures.

Hence the status quo decision to allow the impacts of the previous interest rate cuts (200bps cumulative in 2020) to permeate the economy.

Chapel Hill Denham said: “The CBN’s view on the macroeconomic outlook diverges markedly from consensus view”.

The Bank struck a very optimistic tone for the economy, guiding that it expects the economy to exit recession in 2020, due to stimulus measures and its development finance activities.

Also, the Bank expects inflation to moderate by Q1-2021.

“We see a very low probability of the economy exiting recession until Q2-2021”, Chapel Hill Denham said.

The firm anchored this projection on OPEC+ oil production cut agreement limiting oil & gas sector output, weak FX liquidity, high inflation rate and supply chain disruptions weighing on consumption and fiscal spending.

“On consumer prices, we believe low-base effect, energy price adjustments and supply chain issues will continue to fuel inflationary pressures, until early harvest commences in Q3-2021”, Chapel Hill Denham stated.

Debt Market Investors Advised to Position for Upward Interest Rate Repricing