Prior to the commencement of the MPC meeting, while some analysts had expected the rate to remain unchanged, others had anticipated a hike of between 25 and 50 basis points. The key decision by the MPC was to hike the MPR by 25 basis points, as all other parameters were maintained (the CRR (Cash Reserve Ratio) was kept at 50% for Deposit Money Banks (DMBs) and 16% for Merchant Banks; the Liquidity Ratio was maintained at 30%; Asymmetric Corridor, the difference between the CBN’s lending rate and its deposit rate, was kept at +500/-100 basis points). This gives the CBN flexibility to manage interest rates on either side of the corridor to address market volatility.

What Does This Mean for the Financial Markets?

The MPC’s decision to raise the MPR is clearly a further effort to control inflation and manage the impact of excess liquidity in the economy.

Despite several rate hikes over the past year, the FX market remains unstable, with the value of the Naira fluctuating significantly. The CBN has struggled to stabilise the Naira, and the hike in the MPR is seen as an attempt to attract more foreign investments. This could help alleviate some of the pressure on the FX market, as more capital inflows might provide a cushion to the Naira. However, the FX volatility remains a key issue that may continue to undermine the impact of such interventions.

It is imperative to point out that the latest decision of the MPC will lead to higher borrowing costs. As the MPR rises, businesses and consumers may find loans more expensive, which could impact spending and slow down economic activity. In the banking sector, the high CRR means that banks will continue to have less money to lend, which could affect their profitability. However, banks with strong liquidity positions might find opportunities in the bond market, where higher interest rates can yield better returns.

The actions by the MPC are ultimately designed to bring inflation under control. However, whether this will have the desired effect remains to be seen. If businesses pass on higher costs to consumers, inflation may remain high despite the rate hike. Similarly, if borrowing becomes more expensive, it could reduce consumer spending, which in turn might slow down economic growth.

In the foreign exchange market, the CBN’s interventions will likely continue to face challenges, particularly as foreign investors keep a close eye on the stability of the Naira. While the higher MPR could help to attract investment, the ongoing FX volatility remains a major risk for the economy.

Investor sentiment in the near-term is likely to be mixed. While higher interest rates typically attract foreign capital looking for better returns, the overall economic environment remains uncertain. High interest rates are often a signal of underlying economic challenges, and this might deter some investors who are concerned about the long-term health of the Nigerian economy. On the other hand, investors in government bonds and other fixed-income instruments might find the current environment more attractive as returns rise.

Going forward, the Naira’s appreciation may signal some stabilisation or improvement in investor sentiment, which could have positive implications for demand for bonds and other fixed-income securities. When the Naira strengthens, foreign investors may view it as a sign of reduced currency risk, making Nigerian bonds more attractive.

Some segments of the market have questioned the efficacy of MPR hikes considering the somewhat non-responsive stance in the yields on debt instruments. It is very likely that the 25 basis points hike was far less than expected and potentially priced-in by markets. It was astonishing for many, but logically prudent for the CBN to reverse the cap-volume on SDF placements by banks. This move, communicated via a circular on Friday is expected to neutralise the impact of the market’s disappointment with the extent of hiking.

There are some market participants who believe the last 50 basis points hike in MPR resulted in a 10% (approximately) devaluation of the Naira to $/₦1,700. We, however, are of the opinion that the devaluation, although coincided with the rate hike, was the effect of broader pressure on the currency (in some regards, seasonal) and had no direct correlation to the MPR hike. In fact, some schools of thought adduce that a higher MPR should translate to a revaluation of the currency (hence CBN’s adoption of the approach). In many regards, the correlation between the MPR and exchange rates is indirect, while there is a more direct symbiosis between the MPR and interest rates. In line with this, for each MPR hike, interest rates have followed suit, albeit delayed in some instances.

Nigeria’s GDP growth in Q3 2024 reflects a mixed, but optimistic outlook. The Services sector remains the dominant driver of growth, while the Agriculture sector continues to grow, albeit at a slower pace, and the oil sector shows incremental improvements. The strong performance of the Finance and Insurance sector also highlights the resilience of the economy. However, the challenges in oil production and agriculture still pose risks to long-term stability and diversification. Going forward, it will be crucial for Nigeria to continue promoting growth in sectors like Services, Finance, and Agriculture while addressing the challenges in the oil sector and ensuring that the economy remains buoyant in the face of global economic shifts.

As the year draws to a close, market participants are increasingly speculating about key developments and decisions that could lead to a significant decline in yields before the year ends. Several factors could influence this potential decline in yields. A positive movement in the foreign exchange market, like the Naira’s recent appreciation, might signal a more stable macroeconomic environment, prompting greater investor confidence and an increased appetite for fixed-income securities.