Economics… September headline inflation eased to 8.3%, but it is not eureka yet (4)

Broadly, in line with our expectation, the National Bureau of Statistics (NBS) announced a 20bps ease in YoY headline inflation rate to 8.3 percent in September.

This benign inflation rate, which reflects lower food inflation of 9.7 percen in the month (Vs. the 14-month peak of 10% in August) marks a trend reversal of the six consecutive months rise in headline inflation from 7.7 percent in February to 8.5 percent in August.

Good to note, Core Inflation (the anchor rate for monetary policy transmission) remained stable at a 15-month low of 6.3 percent, reflecting the fairly stable prices of non-food consumer goods. Interestingly, our outlook on October inflation suggests relative stability in headline inflation at 8.3 percent.

That said, it is not eureka yet, as off-harvest season in November/December suggests higher food prices. In addition, brewing election and yuletide spending may accelerate both food and non-food prices, especially as recent pressure on the naira have pass-through effect on inflation.

More importantly, we do not expect the ease in inflation to impact the yield curve in the near term, as the risk-off sentiment of investors will dominate the yield curve. Yesterday’s PMA result reinforces our view; as the marginal cut-off rates of 12.140 percent, 12.790 percent and 12.699 percent on the 3-, 10- and 20-year bonds are six-months high.

Thus, we reiterate our view of higher yield in the weeks ahead, with relative appetite for the short-end of the yield curve, which presents opportunity for asset re-pricing as yield rises. Notably, protracted weakness in crude oil price to four-year low and bearish outlook (oil price is yet to bottom) may renew concerns over probable devaluation of the local currency, as fiscal revenue, current account balance and external reserve may come under pressure in the months ahead, with implication for the ability of the CBN to sustain Naira defense beyond 2014.

July Headline Inflation rate printed at 8.3 percent: Declining 20bps from August level, the YoY headline inflation rate settled at 8.3 percent; reflecting the 30bps moderation in food inflation to 9.7 percent – the lowest in the last five months.

Notwithstanding, protracted insecurity in the North (food basket of Nigeria), which has partly disrupted agro-allied trade, prices of all major food categories were relatively stable, partly supported by the harvest season. Interestingly, Core Inflation, which is the “real anchor rate” for monetary policy decision remains soft at 6.3 percent – the lowest in 15 months. Notably, October inflation should be benign, as we project 8.3 percent for the month, given the base effect, stable prices of non-food items and impact of tail-end harvest season on food prices.

…with more pressure ahead: While money supply growth remains modest at 5 percent annualised rate, brewing election and yuletide spending may renew inflation pressure. More so, recent pressure on the Naira signals imported inflation (effect of Naira depreciation on consumer goods prices). In addition, food prices may rise in the months ahead, being off-harvest season, especially with likely rise in demand during festive season. Thus, we look forward to renewed inflation pressure before year-end, but headline inflation rate should remain below CBN upper target of 9 percent.

Look forward to soft selling on treasury bills but bond yields should be stable: The yield curve will be dominated by the risk-off sentiment of investors, as protracted weakness in oil price and bearish outlook on fiscal finance renew concern on Naira devaluation. Whilst demand from local investors may provide support for the yield curve (given interbank market liquidity), as foreign investors sell-down Naira-denominated exposures (both equities and Sovereign Notes), probable rise in public borrowing (rise in primary market supply) to bridge imminent increase in fiscal deficit will reinforce investors’ appetite for higher yield, going forward. Thus, we reiterate our view of higher yield.

Iheanyi Nwachukwu