June 20, 2022/United Capital Research

Earlier this week, the National Bureau of Statistics (NBS) published the Consumer Price Index (CPI) report for May-22. According to the report, the headline inflation climbed 89bps to settle at 17.7% y/y in May-2022, from April’s 16.8%, printing above consensus forecast of 17.5% and our in-house forecast of 17.4%. Interestingly, the inflation print of 17.7% represents an 11-month high. On a m/m basis, the headline CPI rose by 1.8%, 2bps higher than Apr-22’s m/m inflation. The surge in May’s inflation shows the multiplier effect of surging energy prices, rising food prices (as we exit the harvest season) and thinned out impact of the high base effect.

Across the sub-indices, food inflation rose the fastest, continuing its steady 3-month rise as it expanded 113bps to print at 19.5% y/y in May-2022, from 18.4% in Apr-2022. On a m/m basis, the food sub-index climbed 2.0% in May-22. Interestingly, m/m increase in food inflation has hovered around the c.2.0% mark over the past three months, a sign of unabating pressure on food prices. In recent months, the surge in food prices have been driven by festivities-induced demand pressures as well as supply-side constraints. However, as we highlighted in our April inflation note, supply-side disruptions are coming to the fore. These disruptions include rising cost of importing fertilisers, increase in cost of farm inputs (seeds & machineries) and associated logistics costs. Interestingly, media reports confirmed farmers are now opting for manure as an alternative to fertilisers. These issues are notwithstanding legacy inhibitions to food supply such as the infrastructure deficit, and uncontrolled insecurity in food-producing communities. Seasonal factors and post-harvest losses have also contributed to food inflation.

In tandem, the core inflation sub-index rose 72bps to print at 14.9% in May-22, from 14.2% as of Apr-22. On a m/m basis, the core sub-index rose 1.9% m/m, 65bps higher than the 1.2% m/m increase recorded in Apr-22. In line with the current elevated inflation environment, all the components of the core inflation basket trended higher m/m. The surge in core inflation continues to reflect the impact of the global energy crisis as higher diesel and gas prices continue to impact on Housing & Utilities costs, Logistics cost, as well as Operating costs in the Education and Health Sector.

Outlook: Inflation expected to hit six-year high in June

Looking ahead, we maintain expectations of upward pressure on inflation for the rest of the year. Food inflationary pressures are expected to remain through H2-2022. Farm inputs (particularly fertilisers) are expected to continue to surge in prices, making farming costs significantly higher. This is likely to have a double-pronged impact in the form of weaker farm output during the harvest season as well as higher ex-farm prices. Also, we note that as we approach the planting season, the impact of post-harvest losses will become apparent as food supply wanes, driving prices higher. In addition, we note that farm output during the harvest season (from September) will likely be weaker (relative to recent seasons) due to higher farming costs and further reduced farming population. Another factor likely to sustain pressure on food prices is protectionist policies from food-producing countries, a move designed to ensure circulation of food within the producing country before fulfilling export quotas. Lastly, we expect legacy inhibitions to food supply would remain long-term drags on food supply and consequently drive prices higher.

For core inflation, we expect the biggest source of concern to remain energy costs. Crude oil and Gas prices have remained elevated and despite emerging concerns on global oil demand, high oil and gas prices are expected to persist for longer. We expect the biggest impact for Nigeria to be on deregulated products like diesel. The impact of higher petroleum product cost will be magnified by impact on logistics cost (transportation basket), and Housing & Energy Costs. In addition, we expect prices of services provided by serviced-based businesses to surge higher (Education, and Recreation & Culture) as they navigate a higher operating cost environment. Lastly, we note that manufacturers have had to rely on sourcing a decent chunk of their FX needs from the parallel market as commercial banks struggle to keep up with demand. The persistent depreciation in the Naira at the parallel market coupled with the impact of higher inflation in import partners’ economies will continue to drive upward pressure on prices of imported and manufactured goods. Overall, we project a combination of these factors will continue to place upward pressure on core inflation basket.

Putting the factors we have discussed together, we project an inflation print of c.18.6% for the month of June which would represent a six-year high (since Jan-2017).

Sustained inflation surge…Food for thought for monetary policy

In the most recent Monetary Policy Committee (MPC) meeting, the committee highlighted the surge in inflation rate as one of the primary reasons for its decision. With inflation expected to begin to tread five/six-year highs from June, the MPC may be forced to consider further tightening stance in its July meeting. That said, we expect the MPC to argue that most of the current inflationary pressures are largely cost-push driven, in an attempt to reduce importance of further immediate rate hikes. In addition, the MPC may argue for the need to see the impact of the May hike on price stability before implementing further hikes.

From our viewpoint, despite the stronger inflation driver being cost-push components, we note that demand-pull factors remain as strong inflation drivers while the artificially low naira interest rate environment is driving interest in FX-denominated assets, sustaining recent speculative activities in the FX market.  Thus, we see further room for a 100bps hike in the MPR in 2022 but with lack of clarity on the timing of the hikes. Our base case scenario is an increase in Capital Reserve Ratio in July meeting (but depends on the CBN’s willingness to allow interest rates find their level) and two 50bps hikes in September and November meetings.

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 avoided while obligated-investors retain preference for short duration instruments in bid to manage mark-to-market losses and maximise reinvestment opportunities.