Headline Inflation dropped to 8.4% year-on-year in June 2013, 60 basis points lower than 9.0% in May on ‘base effects’ from last year. The Core Inflation Index rose by 5.4% year-on-year in June, down from 6.2% in May, extending its downward trend thus far this year whilst the Composite Food Index rose 9.7% in June, up from 9.3% in May, on lower food supplies inventory, according the National Bureau of Statistics.
Inflation in the States: Headline Inflation rates lower than the National rate (8.4%) were recorded in 22 states (including the FCT) whilst Inflation rates in 15 states were higher than the national rate.
Of the 3 states housing seaports, where lower prices are expected as hinterland transport costs do not feature in prices, only Lagos State recorded single-digit inflation rate (4.27%), Rivers and Cross River States recorded Inflation rates of 20.8% and 19.2% in June respectively. Ironically, Food inflation in Benue State, the famed Food Basket of the Nation, was 35.08%.
INFLATION FIGURES; ITS IMPLICATIONS
a. Policy
With June’s Headline Inflation rate at 8.4%, inflation for the first half of the year settled in single digit, averaging 8.9%. However, risk factors such as oil revenue shortfalls as production fails to match projections, and the recent slide in external reserves make the Naira cause for serious concern and therefore pose upside risks to inflation. With the Real Effective Exchange Rate showing that the Naira is already overvalued*, adjusting the exchange rate band is a probable option for the CBN. The other viable alternative is to raise rates, as maintaining Naira at current level is seemingly costly.
b. Fixed Income Markets
Driven by aggressive withdrawal of offshore investors’ interest, average yields on actively traded FGN bonds increased in June across all maturities. It appears that the Nigerian bond market has dissociated itself from inflation dynamics lately, such that yields are responding to other demand and supply factors. The correlation between inflation and yields so far this year has been negative. This dissonancement makes it unlikely that single digit inflation expectation will readily transmit to the market.
c. Equities Markets
The Nigerian Equities market took a hit in June, with its year-to-date return at the end of the month (and consequently of the first half of the year) at 28.8%, as against 34.6% at the end of May. The real return on Equity (return after providing for inflation) as of the same date is 24.34% year-to-date, down from 30.85% at the end of May. Notwithstanding the lull in equities markets in June, its real returns dwarf real yields on currently trading FGN bonds and this should serve to stimulate greater appetite for equities, but bonds are still viable for diversification.
d. Companies
The Q2 corporate performance and earnings release season has yet to kick in, making commentary on the real values of turnover, assets and other relevant corporate ratios impossible at this point. However, Headline Inflation has remained in single-digit territory for the entire first half of the year; this suggests a slowdown in the value erosion of consumers’ resources. Also, Fast Moving Consumer Goods Companies (FMCGs), whose raw materials and inputs feature in the inflation basket and for which inflation significantly impacts cost of production, are getting a good deal on Inflation outcomes so far this year as well as the positive outlook for the second half.
INFLATION OUTLOOK
Inflation averaged single digit in H1 2013, and the outlook for H2 suggests inflation will be benign, but with possible shocks as the year winds up. We expect July 2013 inflation at 8.8%. Inflation during the second half of the year is expected to hover around high single digit. Pressure on Naira has seen the USD/NGN exchange rate remain outside the upper band (NGN160/US$) in markets outside the Official, and depending on the intervention by the CBN, this may continue till the end of the year, with implication for prices, particularly imported inflation. We also expect prices to be impacted by the expansionary fiscal stance of the government. There, however, is a one-month lag in the transmission of exchange rate, and government spending changes to prices.