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CBN may tighten monetary policy this month – Report

By on November 4, 2014

The Central Bank of Nigeria will likely decide to tighten monetary policy in its meeting this month, if the decline in global oil prices continues, according to a new report by Ecobank Research.

Ecobank in the report says there is a strong possibility of further direct tightening by raising the Monetary Policy Rate given the recent, sharp fall in Brent oil prices, and uncertainty over the normalisation of US monetary policy following the end of Quantitative Easing in several days.

Brent crude, the benchmark against which Nigeria’s oil is measured, has declined by around 25 per cent since June when it peaked at $114.68 per barrel. The decline is as a result of increased supply from the Organisation of Petroleum Exporting Countries, Shale oil production in the United States and weak demand from Europe and Asia.

“If Brent oil prices fall below $80 per barrel from the current $85.8, this would undermine the naira given that hydrocarbons account for 98 per cent of export revenues and around 75 per cent of fiscal revenues. Under such a scenario, the CBN would likely decide to tighten policy in its November meeting.”

Although a rise in the MPR is currently unlikely, tightening could be made by raising the Cash Reserve Requirement on private sector deposits, according to the report.

The CRR currently stands at 15 per cent. It was last raised from 12 per cent in March 2014.

“Another risk facing the CBN is the possibility of increased government spending in the run-up to the February 2015 election. Any injection of liquidity above target will undermine macroeconomic stability by pushing inflation up above the most recent level of 8.3 per cent in September.”

Noting that inflation had been largely stable around this level for more than one year, Ecobank said the CBN considered the inflation outlook was good with single digit inflation likely by year-end.

The tight monetary policy stance was adopted in order to ensure exchange rate stability (given the managed float exchange rate regime), and help contain inflationary pressures, according to the report.

“Indirectly, the tight policy has helped underpin real returns on fixed income securities investments by attracting foreign investors into naira-denominated assets, thereby helping strengthen demand for the naira (uncovered interest parity forces).”

“We currently expect the CBN to tighten policy as a means of underpinning the naira – currency stability is a key focus for the authorities. The MPR will remain above 12 per cent for the weeks ahead, with the possibility of indirect tightening in the November meeting of the Monetary Policy Committee.

However, if the naira weakens in the interbank market to N170 or more, and oil prices drop below $80 per barrel, it is possible an emergency MPC meeting could be called to address mounting pressures, particularly in the expectation of increased liquidity from election-related spending.

“Under this scenario, the MPC could decide to raise the MPR 50-100bp, and also increase CRR on both the public and private sectors deposit to 100 per cent and 20 per cent respectively. With the policy rate increased, market rates on government securities would move up as follows: 364-day Treasury bill rates: 11.50 per cent to 14.0 per cent; FGN bond marginal rates for 3 and 5-year: 12.0 per cent to 14.0 per cent, and inter-bank naira exchange: $1: N164-6,” according to the report.