Cause of inflation this time – It is not demand-pull but cost-push

The National Bureau of Statistics recently released the official inflation rate for June 2015 at 9.2 percent, a 0.2 percent increase from May’s 9.0 percent. This higher inflation rate was widely expected, given the prolonged fuel scarcity and shortage of perishables. It is important to underscore the impact of this increasing trend in inflation rate on consumer expectations and behaviour.

Aberrational or consistent?

The rising inflation is likely to be aberrational but the trend is becoming more consistent and is fuelling the fear factor. Anticipated inflation is more important than historical inflation because it influences consumer behaviour and preferences. Demand for goods will increase if people expect prices to rise in the near future. As demand increases, producers would be forced to increase prices up to a point that there is a struggle of bargaining power. At this level, it is the price elasticity of demand that determines if there would be a further increase in prices. Another threat to inflation is the possibility and timing of the subsidy removal, which is now becoming more inevitable.

MPC will be in a tight spot

This increase in the price level will be one of the key considerations at the next Monetary Policy Committee (MPC) meeting on July 23 and 24. The MPC is facing the typical monetary policy trilemma of increasing inflation, currency pressures and interest rate stability. While a decrease in interest rates is politically expedient to stimulate economic growth, it may not be the appropriate move due to currency and inflationary pressures. The increased liquidity in the system from the bailout funds is another factor that the Central Bank of Nigeria (CBN) would have to consider. The CBN will be reluctant to increase interest rates as monetary policy tightening is almost reaching its upper limit. The CBN could alternatively increase its use of administrative tools such as cash reserve ratio (CRR) and Open Market Operations (OMO). 

Even though the CBN is committed to defending the Naira, the currency pressures facing Nigeria are becoming more intense. The spread between the interbank rate and the parallel market creates an arbitrage corridor for speculators, and is now a round-tripper’s paradise. Another issue that is of concern is the consistent decline in oil receipts as a result of falling oil prices, when the sanctions on Iran are finally removed. 

Inflationary expectations in July and August

Increased demand for fruits during the Ramadan fasting period in July will lead to a seasonal rise in prices. Inflation in the near term will also be affected by the new restrictions in the forex market and the effective depreciation of the Naira. With recent calls for an upward review of the current minimum wage of N18,000, the Nigerian Labour Congress may intensify its demand for an increase in the national minimum wage due to the persistent inflation.

Impact on stock market

While the stock market is historically inflation-neutral, investors fear that higher inflation will virtually lead to a rise in interest rates and fall in stock prices. They will therefore begin to go short on stocks. Thus far, the NSE ASI has returned -9.5 percent YTD, with inflation-adjusted returns on equities falling from -11.0 percent in May to -17.1 percent in June. The dollar-adjusted inflation after considering the depreciation of the Naira is 35.5 percent. As exchange rate is interest rate-driven, the outcome of the MPC meeting will have an effect on the currency.

Regional peer comparison

Many African countries are also facing inflationary pressures. Angola’s inflation rate rose to 9.6 percent in June 2015 from 8.86 percent in May. Kenya also witnessed a rise in inflation from 6.87 percent in May to 7.03 percent in June 2015, just as Mozambique’s inflation rate rose from 1.29 percent in May to 1.36 percent in June 2015. The central banks of many African countries have taken various steps to curtail the increasing inflation in their respective countries. Most recently, the Central Bank of Kenya raised Central Bank Rate (CBR) by 150 basis points from 10.0 percent to 11.5 percent during its July 2015 MPC meeting.

Conclusion

We believe that the increasing inflationary trend is likely to extend into Q3. Besides the fuel scarcity problem that still lingers – albeit lightly, there has been sustained attacks from Boko Haram insurgents in the Northeast, where many farm products (especially perishables) are cultivated. Lower food supplies would lead to a rise in the food sub-index of the CPI. The appointment of new service chiefs is expected to improve the security situation in the North-east. Furthermore, the aftershock of the CBN’s restriction of importers’ access to foreign exchange at the interbank market would be felt in the coming months. We are already at the upper limit of the tightening cycle, and the more probable outcome at the MPC meeting would be for the CBN to maintain the status quo and use more administrative measures in its quest to protect the Naira in the forex markets.

FDC Economic Bulletin