Last week, we predicted that the Central Bank will raise rates, hold cash reserve ratio at 22.5 percent and retain liquidity ratio at 30 percent. We were accurate and the Monetary Policy Committee made the right decision. We believe the increase in monetary policy rate to 14 percent was a deliberate response to the sky high inflation rate which was reported earlier this month at 16.5percent. Top investors and seasoned analysts were expecting a much different news though and most probably made the wrong bets. Although the CBN claimed that the main cause of the inflation were forces outside the purview of monetary policy, it is noteworthy to mention that money supply grew by 16.52 percent year-on-year against the provisional growth benchmark of 10.98 percent in 2016. Inflation grew by the exact growth in M2. This further reiterates the view of American Economist Milton Friedman that growth in money supply is the main cause of inflation. Essentially, how the MPC decision affects the stock market may not be as obvious as some may think.
In normal circumstances, when interest rates goes up, equities fall and bonds tank. But our current economic situation is anything but normal. The high inflation rate will reduce the real yield on bond investments. This will cause bond prices to fall until it at least equals the new expected rate of inflation or surpasses it. As inflation rate begins to trend downwards in response to higher interest rates as we have observed in the last few weeks, investors will tend to be more bullish on bonds, raising bond prices and cutting yield. However, this may not happen until at least the end of the 3rd quarter.
With higher interest rates, we expect the banks to post better earnings than they did in the last financial year. Bank stocks should rally with this decision. Credit to private sector grew by 28.9 percent year-on-year, outperforming the benchmark growth of 13.38 percent for the year, and we do not foresee a real slowdown in this growth. A combination of higher lending rates and a weak economy though will raise more concerns on the growing non-performing loans in the banking industry. In general, we are bullish on bank stocks especially those with high new loans growth and low non-performing loans book.
We believe that the real economy will not suffer much from higher interest rates. With inflation rate soaring, driven primarily by a surge in the price of goods and services in the market, we believe that the higher cost of borrowing will simply reduce the size of the increased profits which industries were projecting with their higher product prices. We expect a bullish market reaction to the Central Bank's decision as investors realize the MPC made the right call for the economy.
We advice investors to be long on stocks and observe the bond markets till net returns on bond yields after accounting for inflation turn positive before returning to the debt market. Our bet is that stocks continue to pick up and gain momentum as the year draws out and Nigeria attracts more foreign investments into the market with smart monetary policy decisions.
Emeka Ucheaga,
Managing Partner,
Emeka Ucheaga Advisory
I think the CBN should have held it a little while. The inflationary pressures are more from the cost side rather than the demand side taking into account domestic fuel price, transportation cost and so on. increasing the interest rate will just make the cost of borrowing higher and cost of doing business. They (cbn) highlighted the need for fiscal side to be speed up which is spot on, noting that the inflation is as a cause of structural deficiencies. just to add, I think most people expected the increase and those who were able to manage their positions were lucky and fast.
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