Flash Report /

Nigeria unexpectedly cuts rate; decision unlikely to move yields in the market

  • Central bank cuts rate by 100bps to 12.5% – the first since March 2019 and the largest since 2016

  • Lower rate expected to boost lending and reverse recessionary trend, as inflation risk takes back seat

  • Rate cut largely inconsequential to the domestic fixed income market as liquidity generally drives rates

Nigeria unexpectedly cuts rate; decision unlikely to move yields in the market
Nkemdilim Nwadialor
Nkemdilim Nwadialor

Equity Research Analyst, Financials

Stuart Culverhouse
Stuart Culverhouse

Chief Economist & Head of Fixed Income Research

Tellimer Research
29 May 2020
Published byTellimer Research

The Central Bank of Nigeria (CBN) unexpectedly cut its benchmark lending rate on Thursday to 12.5% from 13.5%, to stimulate growth following the downturn brought on by the coronavirus pandemic and sharp falls in crude oil prices. This rate cut takes Nigeria closer to negative real rates, as inflation rate stands at 12.34% vs the MPR at 12.5%. The CBN, however, retained its Cash Reserve Ratio (CRR) at 27.5% and Liquidity Ratio at 30%. 

The MPC decision came as a surprise as the central bank has closely monitored rates for the last two years to curb inflation, support the naira and attract foreign investors to its debt market. Considering the high and rising inflation (12.34% in April) – the highest in more than two years – and recent naira devaluation, the CBN clearly appears to be more worried about growth and trying to stop an even deeper recession than inflation risks, which might suggest further cuts are possible over the coming quarters.

Implications for investors

The MPR cut, although unexpected, is consistent with the policies of other central banks across our coverage universe, as they relax their policy stance to encourage a boost in liquidity. For the local fixed income market, the rate cut is more of a signal to investors that rates will not rise in H2 20 as previously expected. We, however, do not see rates on OMO or T-bills coming off significantly on the back of this, as the short-end of the yield curve is already at single digits and well below the inflation rates. We still maintain our ratings on our Nigeria fixed income securities – Hold on the US$ bonds (as the debt service capacity is still manageable) and Sell on local currency (cautious over the FX outlook).

For the equities market, gains from the recent rally will likely outweigh the MPC decision, but looking forward, we expect valuations to be driven by FX considerations more than the domestic growth outlook, barring any rebound in oil prices.

Avoiding deeper recession

The lower rate is expected to stimulate credit expansion to critical sectors, which should, in turn, encourage employment, revive economic activity and stimulate economic growth. However, we note that there might be questions about the effectiveness of the monetary policy transmission mechanism in boosting growth in Nigeria, and the extent to which it can really counteract the huge negative terms of trade shock from lower oil prices.

The latest decision to cut rates was unanimous as all 10 members of the MPC voted for a rate cut, with 7 members voting for a 100bps cut, 2 voted for a deeper 150bps cut and 1 voting for 200bps cut. Although the 100bps rate cut should see the CBN's Standing Lending and Deposit facilities (SLF and SDF) fall to 14,5% and 7.5%, respectively, meaning that banks can access cheaper funding for liquidity shortfalls in the CBN's lending window, overall lending rates might not come off significantly as inter-bank market rates (OBB and overnight rates) will continue to be determined by the level of system liquidity.

Nigeria’s Q1 20 real GDP meanwhile (measured at basic prices) recorded a growth of 1.87% yoy, although this was down by 23bps from Q1 19 and by 68bps from Q4 19. However, a sharper deterioration in activity is expected in Q2 20 due to the impact of the lockdown, which disrupted both supply and demand, and lower oil prices; the impact of which would be expected to continue to play out in subsequent quarters. Recall that earlier this month, the finance minister had alluded to the economy potentially contracting by as much as 8.9% in a worst-case scenario analysis on the back of a plunge in crude prices (the IMF expects a 3.4% contraction). The fall in oil prices has resulted in severe revenue shortfall for Nigeria (crude accounts for c80% of foreign currency earnings) with the government slashing its budget and increasing borrowing (last month, Nigeria secured US$3.4bn in emergency funding from the IMF).