Nigeria: MPC likely to raise interest rates in July following Tinubu’s bold reforms

• Next MPC meeting: July 24-25, 2023
• Current policy rate: 18.5%
• EmergingMarketWatch forecast: 20.5% - 21.5%

The MPC will hold a policy rate meeting on July 24-25 and we believe the MPC will hike interest rates by 200bps or 300bps due to the recent reforms implemented by President Tinubu - namely, removing the costly petrol subsidy and unifying the FX rates. These painful, but badly-needed reforms, aim to address long-standing problems and put the economy on a more solid and sustainable footing. These measures will have very strong first-round inflationary effects so it remains to be seen how effective the MPC will be in reigning in the second-round effects and anchoring price expectations. Further, there are risks that social unrest could derail or outright reverse the reforms, which will deal a serious blow to the reputation of the fiscal and monetary authorities. Overall, pushing forward with these reforms would be a key test to policy-makers and it is too early to assess their impact on inflation. Once the June CPI figures are released (due on Jul 15), we should have better understanding of the first-round inflationary effects.

The MPC members have become more hawkish since the war in Europe began and the personal statements reveal policy makers are more worried by the surging consumer inflation and its debilitating impact on the population than any possible negative impacts on the economy. The high costs of food and other necessities continue to erode the purchasing power of ordinary Nigerians, thereby entrenching food insecurity, poverty and inequality. Further, the monetary transmission mechanism in Nigeria has been relatively weak so the real trade-off is that higher interest rates will increase the burden on the already precarious public finances. The government's limited fiscal resources meant the costly petrol and electricity subsidies had to be financed through more borrowing, in many cases via CBN overdrafts. Repeated deficit monetization has compromised monetary policy effectiveness and raised Nigeria's macro-economic risks even before the 2020 crisis. Meanwhile, fuel shortages and security challenges have intensified the supply-side challenges and mounted more pressure on disposable incomes.