Disinflation without rate relief tightens monetary conditions

Nigeria’s inflation story is finally turning a corner, and many citizens are cheering this development. After a prolonged surge driven by currency depreciation, removal of subsidies on petrol, and supply-side disruptions, headline inflation has eased quite significantly. The disinflation that began in January and gathered momentum in March has indeed blossomed into full force.

By December 2024, Nigerians faced a negative real interest rate of 7.3 per cent, an inflation rate of 34.8 per cent, and an interest rate of 27.5 per cent. The tide has since turned, with the level of real interest now in the positive region and rising. With the latest headline inflation rate of 14.45 per cent reported on Monday by the NBS, the real interest rate now stands at 12.55 per cent, given that the MPR is now at 27 per cent.

This is welcome for some people, including savers and investors who hold fixed-income financial assets. A high real interest rate improves their returns. In an environment where the government has become a big borrower, holders of such assets stand to benefit from rising real rates. The same holds for the local currency, which benefits from such an increase, as it is expected to raise its purchasing power, hence the desirability to hold the currency.

However, the truth is that for households, businesses, and investors, relief remains elusive. Interest rates remain high, credit is tight, and economic activity feels constrained. The reason lies in a less visible but increasingly important dynamic: disinflation without interest rate relief is tightening monetary conditions in real terms.

This paradox is not unique to Nigeria. It is emerging across several emerging markets where central banks, wary of reigniting inflation or destabilising exchange rates, are holding policy rates steady even as inflation falls. In Africa, several other countries currently experiencing high positive real rates because of high nominal rates include Ghana, Liberia, The Gambia, etc. There is a correlation between the high inflation rates in these countries and the high or rising real interest rates.  The central banks raise interest rates to fight inflation, yet when the inflationary pressures eventually recede, the authorities are reluctant to lower the cost of funds.

After the MPC meeting last month, which retained the 27 per cent MPC agreed upon in September, the current real rate will certainly persist until the next meeting scheduled for February.

The MPC hinged its decision to retain 27 per cent in November on two things. First, it said that headline inflation remained high at double-digit levels and required sustained efforts toward further moderation.  Secondly, members believed that the high levels of headline, core, and food inflation suggested that the lagged impacts of previous tight policy measures were expected to continue in the near term.

While this sounds quite plausible in terms of policy timing, it also carries an inherent risk of unintended consequences. In the current circumstance, waiting for the lagged effects of past tightening policies to further squeeze the inflationary pressures could be achieved at the cost of reduced economic activities.

The truth is that costs in the economy are still high because one of the cost elements- interest rate – is still quite high. At a 27 per cent monetary policy rate, businesses are bound to obtain bank credit at much higher costs. There are other cost-inducing elements currently active in the economy, such as power and transportation.

Therefore, leaving the interest rate high in the hope that lagged policy effects will reduce inflation further might simply amount to leaving the economy to its fate, while costs reduce the tempo of economic activities. This might turn out to be a double-edged sword, capable of cutting either or both ways.

While monetary policy is often judged by the level of nominal interest rates, what ultimately matters for economic decisions is the real interest rate. When inflation declines faster than policy rates, real interest rates rise automatically. Monetary conditions tighten even if the central bank does nothing.

In Nigeria’s case, the policy rate remains high after aggressive tightening to contain inflation and stabilizse the naira. It was only in September that CBN reduced the MPC by just 50 basis points. However, as inflation decelerates, borrowing costs in real terms increase. For businesses and consumers, this feels like a fresh round of tightening, even though the central bank has not raised rates further.

Rising real interest rates disproportionately affect investment-driven growth. In Nigeria, sectors such as manufacturing, agriculture, construction, and small and medium-sized enterprises rely heavily on bank credit. Various sources indicate that bank credit to the private sector, overall, declined in 2025 compared to the previous year. This trend is likely to continue into 2026, and if this happens, its impact could be negative for the economy.

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