January 17, 2020/Cordros Report
In our November inflation note, we had argued that consumer prices would firm up, driven by the impact of (1) the sustained border closure, and (2) festive induced demand on food inflation and core inflation (coming from a low base in 2018). True to our prognosis, headline inflation increased by 11.98% y/y in December 2019, the highest since May 2018. The outturn is 13bps higher than the prior month (November: 11.85% y/y) and 7bps lower than our estimate (Cordros Research: 12.05% y/y).
Outlook
With festive induced demand having dissipated and the gradual fading of the impact of the border closure, we expect less pressure from food inflation going forward. Hence, we forecast a 4bps increase in food inflation to 14.70% y/y in January. Elsewhere, while the exchange rate and PMS price stability should ordinarily drive core inflation downwards, we expect the low base of the corresponding period in the prior year to result in a 9.33% y/y rise. Overall, we forecast headline inflation of 12.12% y/y in January 2020.
Over 2020, having assumed (1) VAT hike implementation, (2) border reopening in Q1, and (3) the electricity price hike, our analysis suggests average and year-end inflation of 12.77% y/y and 15.35% y/y, respectively.
Implications for investment
Negative for fixed income investors: Fixed income yields have continued to tank, as evidenced by this week’s Treasury bills primary auction (Yield: 91D: 2.97% | 182D: 4.03% | 364D: 5.36%). With the CBN’s OMO restrictions on local (non-bank) investors expected to be maintained, returns for local investors will continue to fall deeper into negative territory as the gap between fixed income yields and inflation continues to widen.
Positive for the equities market: To gain inflation-adjusted returns, local investors will have to seek volatility and take the risk in the equities market. We note that fundamentals are not supportive of a market correction this year. However, we are likely to see pockets of gains across stocks with attractive dividend yields and strong earnings potential.