Wednesday, August 31, 2016 6:02pm /fdc
Slightly below analyst consensus, headline inflation spiked further to 17.1% in July from 16.5% in June, a 0.6% increase. It was driven mainly by supply shocks, forex scarcity, speculation and uncertainty premium. Most notable in the consumer basket was the increase in the food and core indices to 15.8% and 16.9%, respectively. Food inflation increased to 15.8% in July from 15.3% in June. Both domestic and imported food products influenced the increase in the food sub-index.
The highest contributors to the increase in the food basket were fish, bread, cereals, potatoes, yam and other tubers. Imported food inflation increased to 20.5% in July from 20.1% in June. The core index increased YoY to 16.9% from 16.2% in June, primarily driven by fuel and electricity costs.
The urban areas are still experiencing higher inflationary pressures compared to the rural areas. The urban index increased by 0.8%, from 18.1% in June to 18.9% in July, while the rural index increased to 15.5% in July from 15.1% in June.
Consumer price inflation has become intractable as it is caused by exogenous factors. The depreciation of the naira by 7.1% in the parallel market during the month of July led to an increase in consumer price levels. Imported inflation continues to be a key factor precipitating this increase. The impact of the forex policy that kicked off in June 20 has been marginal as low dollar supply persists due to reduced dollar inflows.
The Nigeria Customs Service revised the template for calculating import duties in line with the new exchange rate regime. This weakened the exchange rate used for the calculations to N286/$ from N191/$ previously, thereby increasing import duties. Foreign investors remain hesitant about participating in the Nigerian market, due to policy inconsistency and lack of clarity as to the direction of monetary policy.
High energy costs, a major driver of increasing inflation in recent times, also contributed to rising production costs. There were diesel supply shortages in July and this led to the increase of 12.61% in the national average price of the product to N206.55 in July, compared to N183.41 in June.
Additionally, a shortage of kerosene, which is used in most Nigerian households, led to an increase in its price to N600/ltr, far higher than the official price of N135/ltr. The average national price of PMS declined to N148/ltr in July from N149/ltr in June.
The rate of increase in the price level which has been declining since February except in the month of May, declined further in July. Given the significant depreciation of the naira as well as forex shortages in August, we expect this upward movement in consumer prices to continue albeit at a slower pace. Even with the harvest season, the impact of imported inflation will still be an albatross towards the CBN’s objective of maintaining price stability.
Monetary Policy Committee meeting – Committee under pressure
With inflation increasing to an 11-year high, the central bank will be under intense pressure on the direction to adjust interest rates. This comes just after it increased policy rates to 14%p.a in July, in spite of negative growth and increasing unemployment. An important fact is that with the average T/Bill stop rate for 182- day and 364- day at 17.8% and 18.5% respectively in August, the MPR may be redundant as the anchor rate.
The GDP report for Q2’16 shows a negative growth of (-2.06%). This is weaker than expected. With inflation slowing, and Nigeria in recession, the CBN is more likely to pursue an accommodative stance at its next MPC meeting.
A persistent increase in the inflation rate erodes economic value and weakens investor confidence. Nevertheless, the lower-than-expected figures for July signal a possible tapering in the rate of increase in consumer prices. This might improve market sentiment and market players are expected to react accordingly.
Fixed Income and Money market
Following a spike in T/Bills rate to as high as 18%, the apex bank seems to be moving towards reducing borrowing costs as the last auction in August showed a decline money market yields. Given that bond yields are interest rate sensitive, the outcome of the MPC is likely to impact the fixed income market. The adoption of an accommodative stance by the MPC will reduce the interest rate on government debt and avert a crowding out of the private sector.
On the money market side, we expect activities to be driven by the liquidity position. The CBN is likely to ramp up its mop-up action to strengthen the Naira. This will tighten the liquidity position and keep money market rates high. Average OBB and O/N rates in July stood at 17.34%p.a.
Foreign equity investors have thus far remained on the sidelines as they monitor policy changes and developments. With the earnings season now over, weaker macroeconomic variables will continue to support negative sentiment at the Nigerian bourse. Expectations of a Fed rate hike this year are also unfavourable for the market. Activities at the stock market will be driven by speculative trading and interest rate sensitivity.