Benign Inflation Outlook Setting Stage for May/July MPR Cut

March Headline Inflation Falls below Monetary Policy Rate, April Forecast at 12.6%
The National Bureau of Statistics (NBS) on Thursday published the Consumer Price Index (CPI) data for March 2018 and in line with expectation, Headline Inflation declined for the 14th consecutive month to print at a 23-month low of 13.34% (lower than the Central Bank of Nigeria’s Monetary Policy Rate - 14.0%) from 14.33% Y-o-Y in February 2018. The 99bps decline implies Headline Inflation has positively surprised for four consecutive months, decelerating faster than analysts’ median estimate of 13.6% though in line with Afrinvest Research projection of 13.4%. The decline in March Headline Inflation follows the recent disinflation trend bolstered by high base effect as Month-on-Month (M-o-M) price growth accelerated to 0.84% relative to 0.79% in February 2018.

Core and Food Inflation Moderates Further Despite Uptick in M-o-M Price Growth
Core inflation (all items less farm produce) measured Y-o-Y fell 53bps to 11.2%, its lowest level since February 2016. This is mainly attributable to high base effect and a decline in energy prices in the month which partly offset pressures in other divisions (Petrol, Diesel, Kerosene and Gas prices moderated 5.3%, 1.7%, 6.8% and 3.0% respectively). Despite the moderation in energy prices in March, Core index M-o-M growth surprisingly inched higher to 0.84% from 0.75% in the prior month. Relatedly, Food Inflation fell by 172bps to 16.1% Y-o-Y from 17.8% in February 2018, also reflecting high base effect from 2017 which offset the marginal increase in M-o-M food inflation to 0.90% from 0.85% in February.

Setting the Stage for May/July MPR Cut
Despite the marginal increase in M-o-M price growth across indices, we think Inflation pressures remain benign on a seasonally adjusted basis as post-harvest food price development in 2018 is substantially more favourable relative to 2017, thanks to above-average harvest recorded in Q4:2017. With strong base effect still in play, we expect headline inflation to continue to descend in the near term, printing at 12.6% in April and 10.7% by year end. The impact of the consistent disinflation trend and benign near-term outlook is not lost on monetary policy. The CBN Governor has consistently guided monetary policy will be anchored by Inflation development, although empirical analysis suggests external account variables are more potent leading variables.

Regardless, with near term outlook for external account indicators positive (rising oil prices and current account surplus, stable FX rate and 5-year high external reserves) and real interest rate forecast to widen to 1.4% in April, the case for easing monetary policy can be argued from both exchange rate and price stability standpoints. As we mentioned in our post-MPC reaction last week, “policy rate cut in 2018 is a matter of when, not if”. Based on our revised Inflation forecasts, we are convinced that all indicators point to a May/July MPR rate cut of between 100bps – 200bps. Our expectation notwithstanding, the impact on fixed income yields will not be substantial as the CBN has already set in motion the easing cycle by deliberately guiding market rates downwards in the past 6 months, in addition to knock-on effect of the FGN fiscal strategy to reduce domestic debt issuance. Hence, rate cut in our view will only align monetary policy with market realities. Our outlook continues to favour gradual yield compression, with short to intermediate bonds falling faster than longer term bonds as the yield curve gradually normalizes.