Wednesday, June 20, 2012 / ARM Research

The NBS today reported a 20bp moderation in headline inflation to 12.7% in May 2012 from April 2012. The NBS partly attributed the year-on-year (YoY) rise in CPI to some farm produce being in short supply due to the farming season. However, it also acknowledged significant increases in catering and miscellaneous services as well personal care products but adjudged the impact on overall CPI to be minimal given their small weights.

Urban and Rural inflation rates rose 0.8% and 0.7% to 14.1% and 11.7% respectively for May 2012. On a month-on-month (MoM) basis, CPI rose 0.75% compared to our 0.82% estimate and was significantly higher than the 0.15% MoM increase in the preceding month. The YoY moderation in spite of the monthly acceleration reflects the drop-off occasioned by the larger 0.85% jump in the base period.

Figure 1: Trend in key CPI Items

Food inflation partially evidences reported pressures

Food inflation accounted for much of the upward pressure on CPI rising 13% YoY and 1.2% MoM. The NBS referenced increases in the prices of vegetables, in particular, as well as of potatoes, tubers, bread and cereals. The 30bps YoY moderation in imported food inflation to 9.9% in May from April (-16bps MoM to 0.91%) further pinpoint the pressure as coming from domestic food inflation which would then have risen 14.1% by our estimates.

FEWS NET offers corroborating evidence in tighter domestic food conditions, citing insurgency, weather fluctuations which necessitated replanting in some regions (and further drawdown on food supplies) and demand from neighbouring companies as the major drivers. From its surveys, the agency reports price increases as ranging from 27% to 36%, for staples from ‘garri’ to millet, across the country.

Our decomposition of food inflation indeed shows that ‘farm produce’ accelerated moderately to 0.3% MoM (April 0.2%) but indicates that much of the jump was from the relatively small ‘food ex farm’ sub-class, which we derived to capture processed foods. This contrived component rose 10.53% MoM (45.8%YoY). By itself, this component contributed 0.5% of overall 0.75% MoM jump in inflation.

Other components much better behaved, driving “core” inflation lower

Other key components including ‘Housing, Water, Electricity, Gas and other fuel’, ‘Transport’, ‘Household Equipment’ and ‘Clothing’ all declined moderately while Education was flat at 12.2%. However, on a MoM basis these components were moderately higher with only ‘Household Equipment’ showing a marginal dip.
 

Our in house estimates of “core” inflation, which excludes energy in addition to food already excluded by the NBS, showed a 11bps and 280bps MoM and YoY moderation respectively to 0.14% and 11.2% for May 2012. Similarly, the NBS’ non-food inflation moderated 210bps to 12.4% YoY but rose a moderate 10bps to 0.3% on a month-on-month basis. In our view this reflects the persistent contraction in monetary aggregates in 2012 with liquidity conditions further tightened by CBN’s mop up and outflows in the forex market.

Figure 2: May movement of some CPI components

Pressures on food inflation to persist

The similar trends reported by both the NBS and FEWS NET have reinforced our concerns for food inflation pressure starting in June. The latter gave some prominence to the disruptive impact civil insecurity was having on flow of food to deficit areas, suggesting to us the full brunt of attacks since 2009 and which have recently escalated might just be cumulating on food production and could persist for some time to come. Combining this with the impact of shortages in food production in 2011, FEWS NET currently has the entire breadth of the extreme north under ‘stressed’ food conditions and expects “food prices may increase further during the lean season in July/September period”. In light of our analysis of the sub-components of food inflation which suggest farm produce had a relatively subdued contribution as the planting season got underway in May, we expect a fuller transmission of food production pressures going forward.

A further point of risk is the current weakness of the Naira versus the dollar. This has the double-pronged impact on making imported food items more expensive while increasing the attractiveness of domestic food output to surrounding CFA-spending countries. Should the currency weakness persist, the benefits of falling soft commodity prices which have supported imported food inflation in recent months could be eroded just as demand from neighbouring countries further escalates. FEWS NET reported that up to 60% of May’s bulk purchases in some northern markets were headed to Niger republic and possibility that global monetary easing could reflate soft commodity prices could yet compound domestic food woes.

But core should stay moderate

Core inflation appears set for a similar pattern as in 2011, wherein after wild swings through April, it settled into more sedate readings for the rest of the year both on a MoM and YoY basis (see Figure 1). We believe constricted monetary aggregates will drive a similar pattern going forward. Indeed while we expect some form of monetary easing later in the year we expect this will only offset extant liquidity pressures from lower crude prices relative to H1 2012. Consequently, we see the impact of any further easing as simply limiting further moderation in core inflation.
 

Figure 3: Long term trend in Core and headline inflation

And overall trend unchanged

In addition, going by recent history, we expect 1st June hikes in electricity tariffs to have only marginal impact on core and headline inflation. conversely, higher import tariffs on wheat flour (100%) and wheat grains (20%) come 1st July should cause these staples to lead imported food higher. Though the full impact may be reduced by relative lack of supplier pricing power in this commodity aided by availability of substitutes, the threat of currency weakness lasting through July as well as reports the FG could still raise rice duty to 100% (after the 25ppt increase to 30% which drove a 120bps jump in the contribution of food inflation in January) indicate the impact could still be significant.  Thus, we expect food inflation to remain the key driver and, keeping an eye on the additional impact of base effects alluded to in prior commentaries, we still expect inflation to peak in June – August.

We expect this peak period to be kicked off by a jump in June as planting intensifies and we move deeper into the lean season and. Combining this with expected intensification of domestic food pressures—which we believe is yet to be fully reflected in May—as well as weaker impact of the dry-season harvest in the North, we estimate up to a 220bps MoM CPI jump in June, implying a ~100-125 bps increase in YoY headline figures for the month. Likely pressures on imported food in July could add to the domestic pressures, adding a further 100-150 bps MoM to the food inflation base, based on similar events in January, and a ~100bps YoY increase in headline figures by our estimates.  Feeding off the jump in June could lead headline inflation to a ~14.5%-15% peak in July. Although August-September should bring some moderation as the early harvest trickles in, the risk of flooding remains and we think the real dip in headline inflation will not occur until October when the main harvest sets in. Overall, with food pressures and core largely maintaining the pattern we envisaged, our expectations for average annual inflation remain anchored around 13%-13.5%.

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Source: ARM Research

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