Taming Inflation With Interest Rate Hike

Nume Ekeghe examines the decision of the Monetary Policy Committee of the Central Bank of Nigeria to raise the benchmark interest rate by 50 basis points and its implication on the nation’s economy

The Monetary Policy Committee of the Central Bank of Nigeria (CBN) last week rose from its 290th meeting in Abuja raising benchmark interest rate by 50 basis points and leaving all other parameters unchanged in line with its tightening stance.

In an effort to curb the rising inflation, the MPC had at its previous five meetings raised the Monetary Policy Rate. The latest makes it the sixth time in a row, as the apex bank races to rein in inflation.

Despite a marginal decline in the inflation in December last year, the rate at which prices rise resumed its upward trend in January and February this year rising to 21.91 per cent last month according to the latest data from the National Bureau of statistics.

At the end of the two-day meeting last week, the 12-member committee resolved by a majority vote to raise the MPR by 50 basis points. In Summary, 10 members voted to raise the MPR by 50 basis points, one member voted to raise the MPR by 25 basis points and one member voted to hold the MPR. 

They all, however, voted to keep all other parameters constant, thus the MPR was raised to 18 per cent, retained the asymmetric corridor of +100/-700 basis points around the MPR, the CRR at 32.5 per cent; and the Liquidity Ratio at 30 per cent.

Inflationary considerations

Speaking at the end of the meeting, the Governor of the CBN, Godwin Emefiele said the MPC had observed with concern, the marginal increase in headline inflation (year-on-year) in February 2023, to 21.91 per cent, from 21.82 per cent in January 2023, a 0.09 percentage point increase. 

“This increase was attributed largely to a minimal rise in the food component to 24.35 per cent in February 2023, from 24.32 per cent in January 2023, while the core component moderated to 18.84 per cent in February 2023, from 19.16 per cent in January 2023. The shocks to the food component were driven by high cost of transportation of food items, lingering security challenges in major food producing areas and legacy infrastructural problems, which continue to hamper food supply logistics.

“Headline inflation, in the view of members, remained high with increased expectations of price development, due to the perennial scarcity of PMS and ongoing discourse around the removal of fuel subsidy. With the prices of other energy products also rising, members stressed the importance of addressing price development, ”he said.

Growth Considerations

With analysts arguing that the consistent tightening will hamper economic growth, the committee noted that while the continued rise in headline inflation remained a significant problem confronting the economy, other macroeconomic variables are moving in the right direction, despite observed headwinds.

Data from the National Bureau of Statistics (NBS) showed that Real Gross Domestic Product (GDP) grew by 3.10 per cent in 2022. In the fourth quarter of 2022, it grew by 3.52 per cent (year-on-year), compared with 3.98 per cent in the corresponding period of 2021 and 2.25 per cent in the preceding quarter. 

The MPC noted that the economy maintained a positive growth trajectory for nine consecutive quarters, since exiting recession in 2020.

“The improved performance was driven largely by sustained growth in the services and agricultural sectors, a rebound in economic activities associated with economic recovery and continued intervention in growth enhancing sectors by the Bank. Staff projections showed that output growth recovery is expected to continue into 2023 and 2024, ”it stated.

Having it in mind that loosening could reverse the slowing rise in inflation, the committee had considerations had been on continuing its tightening to further dampen the rising inflation trajectory or hold to observe emerging development and allow for the impact of the last five rate hikes to permeate the economy. 

Emefiele noted, “The MPC observed the continued upward risk to price development around expectations on the removal of the PMS subsidy; rising prices of other energy sources; continuing exchange rate pressure; and uncertain climatic conditions. These in the view of members, provides a compelling argument for an upward adjustment of the policy rate, albeit, less aggressively. The Committee, however, noted that the naira redesign and cash withdrawal limit policies have resulted in a sizeable reduction in Currency-Outside-Banks, indicating an expected improvement in the potency of monetary policy tools.”

Imported Impact Considerations

Asides from these, the committee also considered the impact of international events on the economy. The MPC noted that renewed fears of a global financial contagion are forcing investors to move away from the equities market to safer assets such as gold, while others seek higher returns in treasury securities with improved yields.

“With several Advanced Economy central banks progressing with monetary policy normalization, global financial conditions will likely remain tight, thus reinforcing the reassignment of financial portfolios to reflect the risk aversion of investors.

“MPC focused its attention not only on the inflationary trends in most major economies, but also on the reported impact of policy rate hikes: aimed at rein-in inflation on financial system stability in the global financial system.

“The MPC hence took time out to discuss the recent bank failures in the US and Switzerland, an event that occurred following the persistent interest rate hikes in the US, and how this has adversely impacted the broad portfolio of banks in the US. It noted that whereas MPR was increased by 500 basis points in Nigeria, from 12.5 per cent in 2022 to 17.5 per cent in January 2023, the Financial Soundness Indicators (FSIs) in Nigeria shows that the Nigerian banking system remain resilient due largely to the stringent prudential guidelines put in place by the CBN which has resulted in a strong build-up of not only the Cash Reserve Ratio (CRR) in Nigeria, but also the Liquidity Ratio and capital Adequacy Ratio, “it stated.

Analysts Take

To analysts at Cowry Assets Management Cowry Research, the 50bps increase in the policy rate as a tool to tackle accelerating inflation could possibly lead to slower growth and further drive down the total money supply with the aim of achieving sustainable economic growth and price stability. 

According to them, “However, rising inflation has continued to be a front burner in most economies across the globe, including Nigeria, and is escalating the price stability plans far from the hands of the monetary authority—an economic growth trade-off that may further drive the central bank’s position for an extended contractionary stance. Similarly, we continue to see the downside risks of pressures from inflation as the central bank’s aggressive monetary policy tightening measures will largely depend on the path of inflation.”

Commenting on the decision of the MPC, analysts at Cordros Research note that since the SVB’s failure, there has been a material shift in market expectations, with consensus pricing a 25bps increase in the key policy rate apiece at the March and May policy meeting, after which the Fed is likely to adopt a hold stance at subsequent meetings.

“Moreover, despite the recent challenges, we think if the US Fed abruptly stops hiking the Fed rate to drive inflation back to the target, it could damage its forward guidance credibility, driving inflation higher. The preceding could fuel higher rates in the future than currently priced. Thus, we lean towards the current market expectations.

“In our view, these expectations are positive in shaping the CBN’s monetary policy decisions going forward. Nonetheless, in the domestic economy, consumer prices are expected to remain sticky despite the favourable base effects. Moreover, the near-term growth outlook remains clouded by increased downside risks exacerbated by the self-inflicted impact of the CBN’s naira redesign drive amid increased production costs.

“On a balance of factors, given that the end of rate hikes by systemic global central banks is in sight amid sticky domestic inflation, we think the MPC is likely to maintain a slower rate hike at its next policy meeting. Indeed, at the post-MPC conference, the CBN governor guided that maintaining an aggressive tightening poses risk to financial system stability. Accordingly, he stated that the MPC will adopt a strategy of smaller rate hikes going forward to narrow the negative real returns amid the risks of over tightening, ”they stated.