Inflation: After the 'Reggae' Comes The Base Effect Blues


Wednesday, February 22, 2017 4:37 PM / ARM Research

Over the last one year, headline inflation tracked faster, reaching an eleven-year high in January 2017 as the cumulative impact of hikes in electricity tariff and fuel cost as well as naira weakness induced pressures on consumer prices. However, starting in February, we expect base effects from the 2016 drivers to drop off from the chained series, cascading into subdued inflation readings. 

Elevated food prices keep inflationary pressures intact
On Wednesday, the National Bureau of Statistics (NBS) reported that January headline inflation rose 17bps from prior reading to 18.7% YoY– with MoM reading at 1.0% (vs. 1.1% in prior month’s reading). Extending the pattern in recent months, food inflation climbed 42bps from prior reading to an eight-year peak of 17.82%. The upsurge in food prices continues to reflect higher cross border grain purchases as steep depreciation of the naira makes Nigerian produce more competitive. The NBS noted that food price pressures stemmed from higher cereal prices which jumped 132% over 2016. Furthermore, with the conclusion of main harvest season in Southern Nigeria in December, we believe thinning market grain supplies applied upward pressure on food prices.

Core inflation softens despite higher energy prices
In contrast to food, core inflation fell for the second consecutive month (-19bps from prior reading to 17.85%) largely reflecting slower rise, relative to prior month, in Education (-58bps) Restaurants and Hotels (-56bps), Alcoholic Beverage, Tobacco, and Kola (-47bps) as well as Health (-31bps) divisions. Though energy prices rose sharply over the month (Kerosene: +87.1% MoM to N433.84/litre, Cooking Gas +39.4% MoM to N2567.56/litre, Diesel: +22.6% MoM to N240.52/litre and PMS: +1.4% MoM to N148.7/litre), its impact on the Housing, Water, Electricity, Gas, and other fuels division was offset by waning effect of the electricity price hike implemented in February 2016. We attribute higher energy prices to persisting FX supply challenges as well as decline in capacity utilization of the nation’s refineries which weighed on domestic supply of refined products.


Inflation set for a descent as base effects come into view
Attention now shifts to February headline reading where base effects from the 45% electricity tariff in 2016 drop off the chained CPI series. The electricity price hike largely accounted for roughly half of the 2.3% MoM jump in February 2016 inflation. That said, downward pull from the electricity base would be slightly tempered by higher petrol prices currently (N148/litre), relative to February 2016 (N99/litre), and recent uptick in diesel and kerosene prices. 

On the Food inflation side of things, conclusion of the main harvest implies faster depletion of domestic food supplies across markets. Aided by sustained naira weakness which raises incentive for continued cross border exports, that continue to defy FGN’s November ban on grains and higher domestic import substitution, local grain prices should stoke higher food prices in our view.

Nonetheless, recent FGN announcement about releasing grains from the strategic reserves, which directly addresses the issue, could serve to moderate food price pressures. Across both ends, we expect impact of base effects to be paramount in February’s CPI reading and project a 153bps contraction in headline inflation to 17.2% YoY (+/50bps). Farther out, whilst we model PMS increases on higher FX, we see base effects from the 68% petrol price hike as providing strong offsets which informs our mean inflation forecast of 13.9% YoY in 2017 (2016: 15.6%).

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