Will interest rate hike ease Nigeria’s soaring inflation?

Nigeria’s central bank hiked the benchmark interest rate to 14 percent Tuesday, July 19, the highest level since 2019.

The 100 basis point-increase follows a similar hike of 150 basis point only two months ago in May.

The back to back hike was somewhat surprising as it is against what we have come to expect in recent times from the central bank which has been known to be reluctant to raise rates aggressively.

But with inflation unrelenting, it is easy to see why the CBN had to act.

Inflation had risen from 16.82 percent when the Monetary Policy Committee (MPC) met in May to 18.6 percent (the highest in five years) in June ahead of Tuesday’s meeting.

The inflation trend is a global one and explains why interest rates are rising whether it’s in the UK where inflation rose to 9.4 percent in June, the highest in 40 years or nearby Ghana which has had to raise rates to combat soaring inflation.

But will the rate hike be enough to tame inflation in Nigeria?

Let’s establish that Nigeria’s inflation is driven by rising costs of production, a type of inflation economists call Cost-Push inflation, rather than an uptick in demand (or Demand-Pull inflation).

If the cost of borrowing is supposed to rise on the back of higher interest rates, then the hike should further increase business costs and inflation.

But that’s only one side of the story.

The hike in interest rates would have been more effective in curtailing demand-driven inflation, as it will discourage consumption and incentivize savings/investments.

But the rapid rise in the prices of goods and services in Nigeria is certainly not being driven primarily by demand outstripping supply rather it is being driven by higher cost of production, part of which is due to FX shortages.

Given the FX component, it makes sense for the CBN to use higher interest rates to lure foreign investors and their dollars which would improve dollar supply in the economy and ease the cost of buying dollars for manufacturers who need the greenback for critical inputs. That way the cost of production can be reduced.

But the CBN and foreign investors know it will take more than higher interest rates to get them interested in Nigeria. The FX policy is a big disincentive that the CBN needs to address.

The CBN also can’t continue printing money for lending to the government if it is serious about fighting inflation.

Lastly, fighting inflation also requires support from the fiscal authorities in the shape of policy reforms that can encourage trade, investment and boost non-oil exports.

In conclusion, don’t expect the recent rate hike in insolation to solve Nigeria’s inflation crisis, there are other things needed to complement it to achieve the desired result of between 6-9 percent inflation. -Business Day

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