Nigeria: MPC likely to raise interest rates on Sep 26 following Tinubu’s bold reforms

• Next MPC meeting: September 25-25, 2023
• Current policy rate: 18.75%
• EmergingMarketWatch forecast: 19.0% - 19.25%

The MPC will hold a policy rate meeting on Sep 25-26 and we believe the MPC will hike interest rates by 25bps or 50bps 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, but have very strong first-round inflationary effects so we expect the MPC to move and try to reign in the second-round effects and to anchor 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. It should be noted that the CBN has taken some actual measures in tightening naira liquidity recently - it held its first OMO auction in seven months, thus signaling preference for a tighter policy stance. On the other hand, the CBN has allowed a new gap between the official and the parallel FX rates to form, which undermines the confidence in monetary authority. Considering the sharp acceleration in consumer inflation, these all point towards 100bps - 150bps rate increase, but given the MPC's previous increase (only 25bps in July) and the slowdown in non-oil GDP growth, we believe the MPC will opt for a muted rate increase in late September.

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.