By Lukman Otunuga
Unfavourable macroeconomic conditions across the globe have prompted major central banks to embark on a monetary easing cycle to counter a global slowdown.
There is widespread speculation that the US Federal Reserve intends to trim interest rates in order to prevent an economic deceleration in the world’s largest economy. The global financial markets have reacted positively to the idea, which theoretically makes access to funding for business activities easier, boosting investor sentiment and economic growth. The US central bank’s caution is influencing other central banks like the European Central Bank, Bank of England and Reserve Bank of Australia among many others. In Africa, the South African Reserve Bank has already cut interest rates while the Central Bank of Nigeria (CBN) is turning dovish amid deteriorating economic conditions in the wake of trade disputes.
However, in its July meeting, the CBN decided to keep its Monetary Policy Rate (MPR) unchanged at 13.5 percent to allow time for the full impact of other measures. So far, these include a firm bank directive from July requiring 60 percent of deposits to be available for lending to the real economy instead of buying government securities. These securities are high yield because of the current 13.5 percent MPR and understandably attractive to the banking sector seeking stable investments of their own. Making sure money is in circulation instead of being tied up in government bonds sounds like a rational way to keep the economy on the road to recovery.
After surprising markets with an unexpected rate cut in March, the central bank could cut interest rates again during the second half of 2019. However, reducing the MPR when the inflation rate is already at 11.22 percent risks further overheating prices. Like many other emerging economies, Nigeria may be exposed to the impacts of a global slowdown but its economy is very different to the US’ which is currently experiencing anaemic price inflation. This may be why the CBN decided to prioritize reducing inflation to single digits and said it is in no hurry to reduce its key rate. In other effects, foreign investment in Nigeria is likely to see benefits from the CBN’s decision to hold rates at 13.5 percent. This is based on the argument that international investors may be looking for higher-yield securities than those in the mature markets, especially in the light of declining or negative interest rate environments in Europe and the US.
The global monetary easing bandwagon has affected the oil markets differently from global equities. Instead of being heartened by the prospect of better lending rates, investors are focusing on the weaker global outlook for growth and Oil demand. The fact that OPEC decided to maintain its supply cuts until 2020 on the basis of weaker demand for Oil only reinforces the impression that it would take a dramatic event to reignite supply-shortage fears. In addition, the US Oil industry is pumping output at record levels, meaning that OPEC supply cuts are effectively neutralized in terms of boosting Oil prices. These circumstances have pressured Oil price benchmarks, West Texas Intermediary (WTI) and Brent Crude. Oil prices depreciated during the course of July, pulled back by a reverse tide of lower growth expectations.
The third quarter holds the potential for the Central Bank of Nigeria to cut interest rates. A fragile economic recovery coupled with external risks in the form of trade tensions and Oil price volatility should encourage the CBN to re-join the global monetary easing bandwagon. Although a rate cut is in the pipeline, the level of inflation will determine how many times the CBN pulls the trigger on rate cuts. Signs of easing inflationary pressures during the third and fourth quarter of 2019 could offer enough breathing room for the CBN to cut rates to 13% by year end.
* Otunuga is senior research analyst at FXTM