The Central Bank of Nigeria has reduced its benchmark interest rate, known as the Monetary Policy Rate, to 23 per cent, a 350 basis point decrease from 26.5 per cent. This decision was made during the 307th meeting of the Monetary Policy Committee held in Abuja on Tuesday. The rate cut comes as a result of moderating inflation, with headline inflation decreasing to 15.39 per cent in August from 15.43 per cent in July.
The reduction in the Monetary Policy Rate is anticipated to put downward pressure on yields across the fixed income market. This is because investors adjust their return expectations in response to a lower interest rate environment. Prior to the Monetary Policy Committee's decision, fixed income yields had already begun to decline. At its latest Open Market Operations auction, the Central Bank of Nigeria offered N1 trillion of bills, which attracted N6.31 trillion in subscriptions.
The Central Bank of Nigeria allotted about N4.4 trillion at the Open Market Operations auction. Specifically, the 154-day OMO bill cleared at 18.41 per cent, with demand reaching N4.2 trillion against an offer of N400 billion. The true yield of this instrument was 19.96 per cent, down from 20.64 per cent at the previous auction. This trend indicates that fixed income yields are already adjusting to the expected lower interest rate environment.
The impact of the rate cut on fixed income securities will vary depending on when the securities were purchased. Investors holding existing fixed income securities, particularly longer-duration bonds, may benefit from price appreciation if market yields decline further. This occurs because existing securities with higher coupons become more attractive compared to newly issued securities carrying lower yields.
Conversely, investors deploying fresh funds could face lower returns if new Treasury bills, OMO bills, and bonds are issued at lower rates. According to Chukwunonso Iheoma, an Abuja-based economist, a decline in Treasury bill and OMO yields could lead investors to seek higher returns by increasing their allocation to equities, corporate debt, and longer-dated securities.
The Federal Government of Nigeria could also benefit from the sustained decline in domestic yields. Lower yields could reduce the cost of refinancing maturing domestic securities and make new domestic borrowing cheaper. However, the impact on the government's overall debt-service burden would take time, as a significant portion of existing debt was issued under previous interest-rate conditions.
The financial markets are likely to respond first through lower short-term yields, according to Temitope Oduola, a Lagos-based fixed-income analyst. The reduction in the Monetary Policy Rate could reinforce the downward repricing of fixed income securities as investors adjust their return expectations to a lower policy rate environment. Treasury bills and OMO bills are likely to feel the impact first due to their close link to short-term liquidity conditions and monetary policy.
Key points
- The Central Bank of Nigeria's decision to cut its benchmark interest rate to 23 per cent is expected to put downward pressure on fixed income yields.
- The rate cut comes as a result of moderating inflation, with headline inflation decreasing to 15.39 per cent in August from 15.43 per cent in July.
- The impact of the rate cut on fixed income securities will vary depending on when the securities were purchased.
