More than five months into the job as the CBN Governor, Olayemi Cardoso presided over his first monetary policy committee meeting, and he did not hold back, as he increased the interest rate by a whopping 4 percentage points to a record 22.75%.
Governor Olayemi Cardoso, together with his other 11 monetary policy committee colleagues, also tightened other liquidity measures by increasing the cash reserve ratio to 45% from 32.5% and adjusting the bands around which banks can fund and lend money.
What is an interest rate?
An interest rate is the amount of money that borrowers must pay lenders to use their money. For example, when you borrow money from a bank, you must agree to pay interest on the loan. So now that the CBN has increased their interest rate, banks and other financial institutions will follow suit by raising their lending rates, which will increase the cost of borrowing and reduce the demand for money.
Why did the CBN raise interest rates?
According to Cardoso, the CBN raised interest rates due to the “current inflationary and exchange rate pressures, projected inflation and rising inflation expectations.” The central bank hopes to dampen Nigeria’s willingness to spend money by raising interest rates, which makes borrowing money more expensive.
Nigeria recorded its highest inflation in over three decades, at 29.90% last month. The rate hike brings Nigeria’s inflation-adjusted and actual interest rate closer to positive territory, especially with the prospect of more tightening in the coming months.
Cardoso also hopes that increasing interest rates would restore investor confidence, boost remittances to Nigeria, and improve the value of the naira, which has depreciated 43% against the dollar this year, making it the second-worst performing currency in the world behind the Lebanese Pound.
The rate hike would lead to an increase in the value of the naira through what’s called “Carry Trade.” This happens when investors borrow money from countries with low interest rates and invest it in Nigeria, taking advantage of the difference between Nigeria’s high interest rates and the low rates in other countries.
What does this mean for you?
There are tradeoffs to increasing interest rates. When the CBN raises interest rates, borrowing money becomes harder because the cost of borrowing has increased, impacting operating costs, prices of products, and profit margins of businesses. So a hike in interest rates curbs growth, slows the economy as people spend less, and if not properly managed, could lead to economic recession.
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