Inflation Report: Headline Inflation Moderates but Lags Consensus Forecast

The National Bureau of Statistics (NBS) released inflation report for May 2017 during the week with Headline Inflation further slowing on a Year on Year (Y-o-Y) basis - due to high base effect – although it significantly lagged consensus forecast. The Consumer Price Index (CPI) rose 16.25% Y-o-Y (fourth consecutive month of decline) in May, 99 bps lower than 17.2% recorded in April 2017 but 25bps shy of consensus forecast of 16.0%. The lesser than expected decline is majorly attributable to steeper increase in Food prices which drove M-o-M Headline Inflation to 1.9% relative to 1.6% in April 2017.

The Food Sub-index which has been pressured in the last 4 months surged 2.5% M-o-M – the highest month on month jump in 7 years – as farm produce prices remain elevated due to seasonality effect. Food prices are typically higher in Nigeria’s planting season which historically starts in February and lasts till July, although main harvest does not commence until September. The food price pressure in May was particularly skewed towards states in the North Central, South South and South West regions  led by Kwara (4.9%), Bayelsa (4.6%) Nassarawa (4.6%), Akwa Ibom (4.0%) and Ondo (4.0%). By products, the fastest increases were recorded in Protein (Meat, Fish, Milk and Cheese & Egg), Vegetables and bread & Cereals. Despite the faster growth in the Food index M-o-M, Food inflation (measured Y-o-Y) moderated marginally by 3bps to 19.3% in May due to high base effect.

Similar to the Food index, Core Prices rose faster M-o-M, from 1.1% in April to 1.2% in May. However, Core Inflation measured Y-o-Y declined for the seventh consecutive month by 180bps to 13.0% (from 14.8% in April), reflecting the high base effect from the prior year when petrol products prices rose sharply. On M-o-M basis, the highest increases were recorded in Wines & Spirits, Clothing Materials and Liquid fuels.

Our Outlook
In our view, high base effect – which has largely been responsible for moderating Y-o-Y inflation - has started thinning out, such that if the current pace of increases in food prices is sustained, a Y-o-Y increase in Headline CPI may be recorded as early as June. Interestingly, the nature of the renewed pressure on prices is largely structural, hence outside the purview of monetary policy tools which are traditionally more effective in anchoring Core inflation expectation. This should, under normal circumstances, prompt the CBN to ignore the pressure coming from the Food index and start to slightly ease market rates, but we do not anticipate this to happen in the near term as other monetary policy anchors are yet to stabilize to acceptable level.

Of particular concern is the renewed volatility in oil prices and significant spread between interbank and NAFEX exchange rates. This makes the recent recovery in the FX rate fragile until a large depreciation is effected in the Interbank market to converge to autonomous market rate. However, devaluing interbank rate is a political decision as much as it is a monetary policy one, as petroleum product prices are correlated to interbank exchange rate. Thus, we do not expect any changes in monetary policy or market interest rates in the near term until a convergence in exchange rates and sustained stability in core prices.