CBN RATE REDUCTION SIGNALS FURTHER DECLINE IN FIXED-INCOME YIELDS

The Central Bank of Nigeria’s decision to reduce its benchmark interest rate from 26.5 per cent to 23 per cent is expected to place additional pressure on returns in the fixed-income market as investors adjust to the lower interest-rate environment. The Monetary Policy Committee approved the 350-basis-point reduction at its 307th meeting in Abuja on Tuesday, with the move coming as inflation continues to moderate.

Recent inflation figures have provided room for the adjustment, with headline inflation declining slightly from 15.43 per cent in July to 15.39 per cent in August. Food inflation also fell from 20.31 per cent to 19.57 per cent during the period, while month-on-month headline inflation slowed significantly from 1.57 per cent to 0.71 per cent. Fixed-income yields had already started declining before the latest MPC decision, indicating that the market was responding to changing monetary and liquidity conditions.

The trend was evident at the CBN’s latest Open Market Operations auction, where the apex bank offered N1tn worth of bills but received subscriptions totalling N6.31tn and eventually allotted about N4.4tn. The 154-day OMO bill cleared at 18.41 per cent, while demand for the instrument reached N4.2tn against an offer of N400bn. Its true yield stood at 19.96 per cent, down from 20.64 per cent recorded at the previous auction, showing the decline in returns even before the latest reduction in the Monetary Policy Rate.

The lower policy rate is expected to affect Treasury bills and OMO bills first because their yields are closely connected to short-term liquidity conditions and monetary policy decisions. A prolonged decline in short-term yields could eventually influence the bond market, although the pace of adjustment would depend on factors including inflation expectations, liquidity conditions and the Federal Government’s borrowing requirements. Investors who already hold longer-duration bonds could benefit from price gains if yields continue to fall, as securities carrying higher existing coupons become more attractive compared with newly issued instruments offering lower returns.

For investors putting fresh money into the market, however, lower yields could mean reduced returns on newly issued Treasury bills, OMO bills and bonds. An Abuja-based economist, Chukwunonso Iheoma, said investors seeking stronger returns could respond by increasing allocations to equities, corporate debt and longer-dated securities, while those relying on short-term government securities for income could see their earnings decline. The Federal Government could also benefit if domestic yields remain lower, as refinancing maturing securities and raising new domestic debt could become cheaper, although the effect on the overall debt-service burden would take time because much of the existing debt was issued under earlier, higher interest-rate conditions.