Tuesday July 19, 2016 5:10AM /FDC
The spike in headline inflation by 0.9% to 16.5% in June has once again confounded analysts. Some, including the FDC think tank, were of the view that the June inflation numbers will show a marginal decline. However, the dysfunctional forex market was still a critical causative factor in the month even though the new policy kicked off on June 20. The full impact of the new forex regime on inflation will likely be felt in July. 16.5% is the highest price level in Nigeria since October 2005 when it was 18.6%. Nigeria now ranks as the country with the 8th highest inflation in Africa.
Nigeria’s inflationary trajectory still continues to be propelled by supply shocks and spasmodic scarcity cycles. In spite of the decline in average petrol price from N150.3 per litre in May to N148.5 per litre in June, it is baffling that transportation cost increased. In addition, the impact of increasing energy prices was also evident in the price of diesel whose average price rose from N148.8 per litre to N183.4 per litre. Today diesel is selling for N210 per litre. This was principally due to the excess demand as a result of the low output from the national grid (2,364MW).
The rate of increase in the price level has been declining since February except for May. If this trend continues we expect to see July inflation increase by a lower margin than 0.9% in June. In the month of June, the month-on-month change in CPI slowed to 1.7% from 2.8% in May. Food and core inflation increased by 0.4% (YoY) and 1.1% in June. Urban inflation (YoY) rose by 1.0% while rural inflation increased by 0.8%.
Factors driving inflation rate
From June 2015 to January 2016, the rate of inflation has increased by an average of 0.1%. The inflation rate of 9.6% can be described as a natural rate of inflation consistent with slow growth and productivity constraints. However, as from February supply shocks, scarcity and speculation triggered sharp rises in inflation from 9.6% to 16.5%.
The June Data
An analysis of the NBS inflation report shows that the food and core indices increased YoY by 0.4% and 1.1%, respectively. Food inflation increased to 15.3% in June from 14.9% in May. Both domestic and imported food products stoked the food sub-index. The highest contributors to the increase in the food basket were fish, meat, bread, cereals, fruits and vegetables. Imported food inflation increased to 15.3% in June from 14.9% in May. The core index increased YoY to 16.2% from 15.1% in May, primarily driven by fuel and transportation costs.
The urban areas are still experiencing higher inflationary pressures compared to the rural areas. The urban index increased by 1.0%, from 17.1% in May to 18.1% in June while the rural index increased to 15.1% in June from 14.3% in May.
A combination of rising energy costs, weaker naira, and food shortages had a significant impact on the inflationary direction.
Monetary Policy Committee meeting – Trade off between growth and inflation
When policy makers are faced with the dilemma of either inflation or growth, the conventional logic is to choose growth in a period of contraction. However, with the spike in June’s inflation number the jury is out as to the outcome of the meeting. The most probable scenario is to maintain the status quo. Policy makers may not be inclined to tighten further as this could stifle growth and increase unemployment. They are likely to be comforted by the amount of liquidity mopping up due to the exchange rate change. Thus, are unlikely to apply a contractionary interest rate policy in addition to the exchange rate effect.
The impact of persistent inflation is erosion in value and confidence of economic agents. The market is expected to react accordingly to the trend of rising inflation.
Fixed Income and Money market
Bond rates have settled in the region of 14.99% recently. Given that bond yields are interest rate sensitive, we believe that the outcome of the MPC is likely to impact the fixed income market. For the money market, liquidity is low and NIBOR rates are increasing, with OBB and O/N rates at 20.83% and 22.75%, respectively. We expect activity in the money market to be driven by liquidity position.
The Nigerian bourse is volatile and is in search of direction. Any changes in the interest rate environment will increase the rate of volatility. The Scottfree 30-day volatility index as at 15 July, 2016 was 31.27% on a scale of 0-100%, with 100% denoting highest volatility. However, stock market returns will be more a function of corporate earnings than interest rate sensitivity.