Interest rate to fall to 12.5% in 2026 as CBN unwinds tightening

The Economist Intelligence Unit (EIU) expects the Monetary Policy Rate (MPR) to fall to 12.5 percent in 2026 and remain there throughout the remainder of the forecast period, if inflation drops.

In its latest report on Nigeria, the EIU expects the CBN to begin unwinding its tight stance, with rate cuts beginning early in that year, despite inflation remaining above the ceiling of the CBN’s 6-9 percent target range.

“Assuming inflation falls from 2025, we expect the CBN to begin unwinding its tight stance, with rate cuts beginning early in that year, despite inflation remaining above the ceiling of the CBN’s 6-9 percent target range. We expect the policy rate to fall to 12.5 percent in 2026 and remain there throughout the remainder of the forecast period,” the report stated.

Reduced interest rates typically lead to lower interest payments on loans, including mortgages, car loans, and personal loans. This can make it cheaper for households to borrow money for big-ticket items like homes or cars, potentially increasing consumer spending.

While borrowing costs decrease, the returns on savings accounts, and other interest-bearing investments also tend to decrease. This can discourage saving in traditional savings accounts but may encourage investment in riskier assets seeking higher returns.

Lower interest rates mean lower costs for businesses when borrowing money for expansion, investment in equipment, or other capital expenditures. This can encourage businesses to invest more in growth opportunities, potentially leading to increased hiring and economic expansion.

The Monetary Policy Committee (MPC) meeting, which held on February 26 and 27, 2024, raised the MPR by 400 basis points to 22.75 from 18.75 per cent., adjusted the asymmetric corridor around the MPR to +100/-700 from +100/-300 basis points, raised the Cash Reserve Ratio from 32.5 percent to 45.0 per cent, and retain the Liquidity Ratio at 30 per cent.

“The MPC attaches a large weight to economic growth, and policy will be subject to political interference,” the EIU said.

According to the report, another 100 basis points is likely to be added to the policy rate in 2024, assuming deficit monetisation continues and imported inflationary pressures remain strong. However, our core view is that the CBN will fail to deliver a positive real short-term interest rate as doing so would cause unemployment at a high political cost.

The CBN has mentioned a switch to inflation targeting, but as this would rub up against government economic policy and given the CBN’s record of unorthodox policy, such a framework would have little credibility in anchoring inflation expectations.

Nigeria’s inflation rate increased to 29.9 percent in January 2024, the highest since September 2005, and from 28.92 percent in the prior month, according to data from the CBN.

“Given probable deficit monetisation, negative real short-term interest rates and a 45 percent currency devaluation in February, we forecast that average inflation will rise to 30.3 percent in 2024, from 24.7 percent in 2023,” the report said.

The 2024 average reflects the fact that petrol price increases in June 2023 will drop out of the year-on-year calculation from mid-2024, preventing the rate from being even higher. Assuming the naira stabilises, average inflation should fall to 20.7 percent in 2025 and 11.7 percent in 2028. Inflation will thus remain well above the 6-9 percent target range throughout the forecast period, owing to expected VAT rate increases, insecurity in agricultural regions (raising food prices), Nigeria’s infrastructure deficit, periodic monetisation of fiscal deficits, currency weakness and a general inflation bias within economic policymaking, the EIU report said.