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Inflation flat in January, to spike in March?

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The National Bureau of Statistics (NBS) released its January inflation data on February 12, 2014. The year-on-year (y-o-y) CPI was 8%, unchanged from December 2013. The consensus view of most economists was that the rate of inflation will remain flat but with a probability of a marginal increase. Inflation in Nigeria has been muted over the past year mainly because of tightness in money supply aggregates, a stable naira and an increasing interest rate environ-ment.

The CPI declined for three consecutive months before inching up in November. The food index was unchanged at 9.3% for the third consecutive month. However the price of meat, fish and dairy products increased. The non-food index however declined for the first time in six months to 6.6% in January.

The low inflation rate of 8% did not take the market by surprise because of the usual time lag between money supply increase and exchange rate pressure on consumer prices. In other words, the transmission time lag of 4 to 6 weeks had not yet manifested.

In 2013, money supply growth was negative at –4.82% compared to the annual target of 15%. Therefore, an increase in money supply aggregates in January would have no impact on total money supply, since it is starting from a negative base.

There has been increased currency pressure since the removal of the limit on dollar sales to BDCs in 2013. The impact was a sharp depreciation in the naira from N162-176/$ at the paral-lel market. In the informal market where retail trade inventory is mainly financed by dollars sourced in the parallel market, the prices of goods is directly linked to the value of the naira in the parallel market. In December, some traders had slowly started repricing their inventory based on a weaker naira. The effect of this repricing was not apparent because of the seasonal Christmas price increases.

FDC’s Lagos urban inflation survey result was consistent with the trend in the national urban inflation. It showed an increase of 0.13% to 9.57% in consumer prices. There was an excess of supply of food products in the Lagos market in December. Many traders expressed surprise at the low level of aggregate demand during the last Christmas season.

The headline inflation at 8.0% is within the range of 6-9% set by the CBN as the target for 2014. However, what is more important now is the trend of inflationary expectations. A number of manufacturers surveyed were anxious as to the direction of the naira in the forex market. Most of them agreed that they would pass through increased costs in the pricing of their products to the market. Nonetheless, the sentiment of inflationary expectations points to a more pro-nounced increase in prices in February. This is driven by the 50% increase in the cost of gas, which will push up the cost of power for gas-fired generators and the Gencos.

Furthermore, a depreciating naira and depleting external reserves will have a negative impact on the non-food basket. If the FGN implements the new import duty and levy increase from 20% to 70% on cars and light commercial vehicles. There is likely to be a spike of approximately 30% on urban transportation costs. Using today’s car prices, the average price of a 1,800cc Sedan which now costs N4m is estimated to increase to N5.6m. In a 3-year amortisation for a taxi or a Hiace light bus, the fare adjustment will be 30-35%. Urban transportation constitutes approxi-mately 1.35% of the non-food basket. Some of the public transportation cost will be offset by the larger vehicles that use diesel and are not affected by the new tariff.

While inflation remains muted in January and February, the real threats will come in March. This is because the impact of the new automotive policy tariffs and the 50% hike in gas prices will be more pronounced in the markets. In addition, the money supply effect will start biting in March.

Global and Regional Outlook

Increasing inflation in 2014 is not a Nigerian specific problem. In Ghana, the CPI spiked 13.5% and the cedi has lost 5.8% this year. Also, inflation rates in Sudan and Guinea are in double dig-its while Kenya recorded 7.21%.

Inflation in Sub-Saharan Africa is projected to remain moderate in 2013 due to expected low commodity prices and disinflationary trend in low income countries. According to the IMF’s Re-gional Economic Outlook, the maintenance of tight monetary policies by central banks remains a major factor.

In the US, a survey released by the Federal Reserve Bank of New York showed households’ infla-tion expectations increased from current levels, due to rising signs of optimism about the job market. The result of the survey shows a decline of 0.14% reading in January 2014 to 3% from the level in December 2013. The report also indicated that consumers expect home prices to in-crease by 4.54% in 2014. In 2013, the US headline inflation averaged 1.5%, well below the Fed-eral Open Market Committee’s target of 2%. However, the US Fed Chairman expects inflation to trend towards 2% in the short to medium term.

A spike in the rate of inflation in March will undermine monetary policy objectives and threaten macro-economic stability. The CBN Governor has already expressed concerns on the depleting external reserves and has reiterated his determination to defend the naira. However, if the deple-tion in external reserves continues, an adjustment in exchange rate becomes inevitable. The question on everyone’s lips is when and by how much the currency will depreciate especially at a time when the parallel market rate has appreciated from N176/$ to N170/$ and the interbank exchange rate has moved in the opposite direction to N167/$.

The MPC will meet March 17/18 or even earlier if an emergency meeting is called, to review its current monetary policy stance. All indicators are that the markets are in for a bumpy ride in February and March. So fasten your seat belts.

By:  Bismarck Rewane