US policy adjustment, possibility of interest rate cut ahead

US policy adjustment, possibility of interest rate cut ahead.

On Friday, August 23rd, the US Federal Reserve Chair, Jay Powell delivered a much awaited speech at the Jackson Hole symposium hinting at a possible interest rate cut in the coming months.

According to Jay Powell, “The time has come for policy to adjust,” stating that “The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”

The news sent US Treasuries rallying as the dollar fell, indicating that investors were anticipating lower interest rates, which typically increase the value of bonds while decreasing the dollar’s attractiveness compared to other currencies.

For Nigeria, this development could be a much-needed boon for its beleaguered exchange rate, which has been under intense pressure due to recent economic challenges and policy shifts.

As the Central Bank of Nigeria (CBN) grapples with maintaining the stability of the Naira amidst a volatile global and domestic environment, Powell’s signal of an impending rate cut in the US might offer some relief.

The most immediate impact of a US interest rate cut is likely to be a weakening of the dollar. Traditionally, lower interest rates in the US make the dollar less attractive to investors, leading to a depreciation of the currency.

For Nigeria, which has recently undertaken significant measures to stabilize the Naira, including the unification of exchange rates, a weaker dollar could help ease some of the pressures on the Naira.

Since the CBN’s decision to float the Naira and converge the official and parallel market rates, the currency has faced a steep decline, with market forces driving the Naira to new lows against the dollar. The exchange rate has depreciated by a whopping 71% since the forex unification was announced in mid 2023.

This depreciation has exacerbated inflationary pressures and increased the cost of living for many Nigerians. However, if the dollar weakens as a result of the Fed’s actions, the Naira might experience a degree of appreciation or at least a slowdown in its depreciation, offering some respite to Nigeria’s embattled economy.

Nigeria’s inflation rate has remained persistently high, driven by a combination of factors, including the removal of petrol subsidies, the depreciation of the Naira, and ongoing supply chain disruptions. As the cost of imports rises with the falling Naira, inflation has surged, eroding the purchasing power of Nigerians and creating significant challenges for businesses.

In this context, a potential easing of inflationary pressures could be one of the most beneficial outcomes of a weaker dollar. With the dollar losing value, the cost of imports could decrease, which might help moderate inflation in Nigeria.

This is particularly important as Nigeria relies heavily on imported goods, including food and fuel, which are major components of the consumer price index.

However, it’s important to note that the impact on inflation could be mixed. While a weaker dollar could lower the cost of imports, it might also lead to higher global commodity prices, particularly oil.

Given Nigeria’s dependence on oil exports, any increase in global oil prices could offset the benefits of a weaker dollar by driving up the cost of imported goods, thereby keeping inflation elevated.

However, this impact could be mitigated if the September date for the commencement of fuel production from the Dangote Refinery is achieved as planned, which could reduce the need for fuel imports and ease inflationary pressures.

The potential inflow of capital into emerging markets like Nigeria is another key factor to consider. Historically, lower US interest rates have driven investors to seek higher yields in emerging markets, which could lead to increased demand for Nigerian assets and, consequently, support for the Naira.

For example, between 2017 and 2020, when interest rates in the US were near zero, Nigeria attracted around $5 billion a quarter in capital importation. This fell to around $1 billion a quarter when COVID-19 struck and remained at this level until the first quarter of 2024 when it rose to $3 billion.

This influx of capital could help stabilize the exchange rate in the short term, reducing the pressure on the CBN to intervene in the forex market.

However, this scenario also presents risks. The capital flows driven by changes in global interest rates can be volatile and subject to sudden reversals. If global risk sentiment shifts or if the Fed’s policy stance changes unexpectedly, Nigeria could face a rapid outflow of capital, leading to renewed pressure on the Naira and further exchange rate volatility.

For the CBN, navigating this complex global environment will require a careful balancing act. The potential benefits of a weaker dollar and increased capital inflows must be weighed against the risks of inflation and exchange rate volatility.

The CBN has already taken significant steps to address currency instability, but maintaining this stability in the face of shifting global monetary policies will be challenging.

Moreover, the Nigerian government must also play its part by addressing the underlying structural issues that continue to weigh on the economy.

Efforts to diversify the economy, improve revenue generation, and manage debt levels will be crucial in creating a more resilient economic environment that can better withstand external shocks.

Given the potential for a stronger or more stable Naira, some Nigerians may be considering whether now is the time to sell their dollars.

However, while the prognosis suggests a positive outlook for the exchange rate, it’s important to recognize that Nigeria still faces several economic headwinds that could exert downward pressure on the Naira.

The International Monetary Fund (IMF) recently suggested that the exchange rate could fall to around ₦2000/$1 by the end of the year, indicating that the situation may not improve as much as hoped.

Rather than selling dollars in anticipation of a stronger Naira, Nigerians might be better served by focusing on earning foreign revenue.

Those with significant foreign currency obligations, such as school fees, would be better off keeping their dollars. To mitigate the impact of a weaker Naira, they could consider averaging down by continuing to buy dollars as the rate fluctuates.

Historically, the Naira has consistently weakened against the dollar, and the fundamentals of Nigeria’s foreign currency stability remain unchanged, as the country is still heavily reliant on hot money inflows rather than foreign direct investment (FDI).

Moreover, Nigeria has not shown sufficient commitment to increasing exports or becoming self-reliant on goods that could be produced locally.

-Nairametrics