For years, the monetary policy rate (MPR) has been the anchor that has influenced interest rates in the country but no more. Since the second quarter of 2017, the correlation between treasury yield and MPR broke as the monetary authorities chose to hold interest rate at 14 percent despite the steady monthly drop in inflation since Q1 2017.
The Central Bank of Nigeria chose to retain the benchmark rate at 14 percent last Tuesday, explaining that “the holding policy stance will support growth and further moderate inflation”.
Still economic growth has performed below expectation, growing at less than 2 percent while inflation has moderated considerably to 11.65 percent in June from as high as 16.1 percent in June last year.
As inflation trended downwards, so did treasury yields. Even the CBN admitted in the MPC communiqué that the MPR may have lost its signalling effect to the market. Investors are now asking why CBN is waiting to play catch up as money market and fixed income yields have already dropped considerably since inflation began its southward march last year.
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The ten year average yield on federal government bond has also dropped from 16.1 percent in June 2017 to 14.3 percent yesterday, giving investors a risk premium of around 265 basis points as at yesterday compared to zero basis point in June last year.
The observed repricing in the risk free rate provides the Central Bank with enough leeway to cut interest rates as foreign investors whom the Central Bankers are protecting are already earning lower returns in the treasury bills and FGN bonds regardless of their decision to hold the benchmark rate.
Since the goal to keep foreign investors with higher yields won’t work if inflation keeps dropping and pulling treasury yields along with it, it will make sense for the MPC to re-evaluate its monetary policy stance.
CBN forecasts inflation to drop below 10 percent sometime later in the year. If inflation falls further, it won’t be too long before only the MPR remains in double digit while the rest of the market operates in single digit borrowing rate.
Possibly then, the MPR will be dropped to be more market reflective and restore its position as the anchor for all other borrowing rates in the country.