Mar-2022 Inflation Note

April 22, 2022/United Capital Research

At the close of last week, the National Bureau of Statistics (NBS) published the Consumer Price Index (CPI) report for Mar-22. According to the report, the headline inflation climbed 22bps to settle at 15.9% y/y in Mar-2022, from February’s 15.7%, printing in line with our forecast of 15.9%. The increase in inflation came as no surprise, as the ripple consequences of the Russia-Ukraine crisis on energy prices, general increase in global price level, and lingering impact of the recent cycle of accommodative monetary policies continue to trigger upward pressure on prices. On a m/m basis, the headline CPI rose by 1.7%, 11bps higher than the 1.6% increase in Feb-22.

Breaking the headline inflation into categories, food inflation reversed higher after two consecutive months of decline, printing higher by 9bps to settle at 17.2% y/y in Mar-2022. On a m/m basis, the food sub-index climbed 2.0% in Feb-22, up 12bps from 1.9% in Feb-22. The upturn in food inflation is reflective of two critical factors: dwindling impact of the high base effect on food inflation as well as gradual end of the 2021/22 harvest season, reflecting in the m/m surge in food inflation. Meanwhile, legacy inhibitions to food supply such as unabating insecurity challenges, unfavourable weather conditions, low-quality inputs, and supply chain bottlenecks remain. Thus, despite the recent harvest period, food supply remains inadequate amidst sturdy demand.  In addition, food prices with FX-linked pressures remained on the rise as FX concerns and global inflation lingers.

On the other hand, the core inflation sub-index eased by 10bps to print at 13.9% in Mar-22, from 14.0% as of Feb-22, representing the first moderation in five months. Interestingly, on a m/m basis, the sub-index rose 1.0%, 36bps lower than the 1.3% m/m increase recorded in Feb-22. The decline in m/m core inflation and the subsequent y/y moderation comes as a surprise amidst escalating surge in energy costs, housing costs, education, and other utilities. Contrary to the direction of core inflation, all the components of the core inflation basket trended higher m/m while only the negligible health component declined y/y. That said, the highest increases were observed in the Utilities (Gas, Fuel, Electricity & Water), Clothing & Footwear, Alcoholic Beverage, Education, and Transportation costs. The increase seen in transportation costs was underpinned by the increasing cost of petroleum products (particularly diesel). In addition, fuel scarcity and surge in crude oil price continued to impact on energy and fueling costs during the month.

Outlook: Inflation expectations biased upwards

Looking ahead, we do not expect inflationary pressures to dissipate. First, for food inflation, the gradual end to the harvest season is likely to trigger a round of upward surge in food prices and the supply imbalance worsens. In addition, price of fertilisers and key farm inputs have been surging in recent weeks due to supply-side disruptions triggered by the Russia-Ukraine crisis. As a result, we are likely to see upward adjustments in the prices of food items in the coming weeks. Lastly, legacy issues around supply-chain inefficiencies, inadequate storage facilities and in many cases, archaic farming methods are likely to deter food supply growth. As a result, we expect the upward pressure on food prices to continue unabated in subsequent months.

For the core component of inflation, we expect higher energy cost to be a major driver of higher inflation in April. Although the m/m impact is expected to plateau (as energy costs in Nigeria have fairly stabilised since March end), we expect the impact on y/y increase in core inflation will be broadly magnified.  The pass-through effect on transport cost will also be a upward driver of core inflation in April. Lastly, the ripple impact of higher energy cost and global inflationary level on the aggregate domestic prices (particularly on housing, education & clothing) will also contribute to a northward thrust in core inflation.

Aside these highlighted factors, we note that the base effect that has moderated the rate of increase in inflation rate will wear off. Thus, headline inflation rate will likely reflect a lower base impact. Overall, when we put these factors together, we expect the increase in inflation to be faster than in recent months. For April, we project headline inflation will surge to 16.7%, reflecting pressure from energy cost, absence of a high base, and resurgence in food prices. 

Impact for monetary policy and the yield curve

With the inflationary environment projected to remain elevated in the coming months, we struggle to see how monetary policymakers can continue to ignore the narrative. In the first MPC meeting of the year, the committee stated it subscribes to the viewpoint that current inflationary pressures are caused by structural challenges, rather than excess monetary pressures. While we note that this is very true evidenced by food supply challenges and higher energy costs stemming from higher crude prices, we believe some of the pandemic monetary support and credit expansion policies in the past year has led to some monetary-driven inflation. Thus, the committee may be forced to implement at least a 50bps hike in its benchmark interest rate before the end of the year in bid to claw back some of the pandemic monetary support. However, we are unlikely to see this materialise until H2-2022.

For debt market investors, real return continues to head deeper into negative territory as yield compression across the yield curve and higher inflation erodes investment value. However, with the sustained inflationary pressure, expectation of higher government borrowings, and tighter liquidity dynamics, the yield curve is likely to sustain the recent uptrend. Thus, we believe exposure to long duration debt instruments should be reduced with a preference for short term instruments in bid to avoid mark-to-market losses.