Inflation Threat: Analysts Predict Policy Rate Hike

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Inflation Threat: Analysts Predict Policy Rate Hike
Godwin Emefiele, CBN Governor

Inflation Threat: Analysts Predict Policy Rate Hike

To curb the Nigerian jumpy inflation rate threat on the economy, analyst have predicted that the current dovish stance may be coming to a halt, saying the Nigerian Central Bank monetary policy committee will most likely increase benchmark interest rate in May.

To support economic growth, the apex bank has initiated growth driven policy which include increase loans to deposit ratio for banks while maintaining interest rate benchmark at 11.5%.

The two-legged policies that affected banks in Nigeria has resulted to declining average interest income in the banking sector while lenders struggle to meet LDR target.

However, the pandemic-induced economic stress appears to have worsen things for the country who relies mostly on petrol-dollar to drive its growth.

In the past 19 months, inflation rate has maintained an uptrend, the situation that the monetary policy authority attributes to supply chain shocks.

The CBN has targeted inflation rate between 6-9% for the country, but since Federal Government border closure policy in August 2019, price level have been adjusting upward.

The problem with Nigerian headline inflation is in many folds, according to analysts. Naira devaluation has pushed companies’ production costs upward.

In their separate financial statements for 2020, many companies reported foreign exchange losses due to increased cost of importing raw materials majorly.

Others with foreign currency loans also suffer similar faith, but border closure aided ability of fast consumers’ goods operators raising prices.

Also, disruption in the supply chain due to pandemic-induced lockdown in the first half of 2020 fuelled increased in general price level on the average across sectors.

And again, the increase in aggregate money supply pursuing limited output worsen market prices of goods, though borders have been opened, there is still limited flow of goods and services.

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Broadstreet analysts are of the opinion that jumping headline inflation rate make good case for policy rate hike in the next monetary policy committee in May.

The National Bureau of Statistics (NBS) consumer price index (CPI) report for March 2021, which showed pressures on consumer prices remained unrelenting for the 19th consecutive month.

In March, headline inflation rate surged by 84 basis points to 18.17% year on year, the highest level in more than four years.

Also, on a month-on-month basis, headline inflation accelerated to 1.56% mom from 1.54% month on month.

Chapel Hill Denham said in macroeconomic noted that the inflation print was yet another negative surprise, running ahead of consensus expectation of 17.9% and its estimate of 17.7%.

In terms of drivers, food inflation remained the major pressure point, as it printed higher by 116bps to 22.95% year on year, which analysts said is the highest level in more than 15 years.

On a monthly basis, the food index expanded by 1.90% from 1.89% in February, and also above the seasonally adjusted long run average of 1.24%.

Core inflation was relatively benign, rising by 29bps to 12.67%, the highest level in 38 months. Food inflation accelerated on a monthly basis to 1.90% mom in March from 1.89% month on month in February.

“This rise in the food index was caused by increases in the prices of bread and cereals, potatoes, yam and other tubers, meat, vegetable, fish, oils and fats and fruits. The surging domestic food prices could be explained by both international and domestic factors”.

Notably, an international trend of rising food prices has emerged since the onset of COVID-19 pandemic, induced by supply chain disruptions and surging global demand.

Analysts explained that aggregate measure of global food prices, the FAO’s global food index, is up by 24.6% year on year and at the highest level since 2014.

However, Chapel Hill Denham said local factors have magnified the impact of this global trend, including the ill-timed closure of Nigeria’s land borders in Q3-2019, foreign exchange liquidity crunch and restrictions,  an underwhelming planting season in 2020, due to COVID-19 restrictions on migrant labour, and age-long structural challenges.

The firm believe some of these factors have become exacerbated recently, such as insecurity in major food producing regions in the country.

Within the core basket, the highest increases were recorded in the prices of passenger transport by air, medical services, and miscellaneous services relating to dwelling.

Also included among key drivers of inflation rate include cost of passenger transport by road, hospital services, pharmaceutical products, paramedical services, and vehicle spare parts among others.

Outlook

“Inflation figures will get worse before getting better. Over the near term, we maintain our view that inflationary pressures will persist, at least until early harvest of agricultural produces gains momentum in Q3-2021”, analysts at Chapel Hill Denham stated.

Explaining further, analysts said another upside risk to inflation is the possibility of increase in fuel prices, but that appears to have been forestalled.

President Muhammadu Buhari has reportedly ordered the Nigerian National Petroleum Corporation (NNPC) – the sole importer of petrol – to maintain fuel subsidy for another six months despite the increase in the international prices of crude oil.

Analysts estimated that the NNPC is currently subsiding petrol (PMS) by 18% to 26%, but unlikely to pass on the full cost to consumers given political consideration.

Regardless, analysts at Chapel Hill Denham said they expect headline inflation rate to finally breach the January 2017 high of 18.7% year on year in April 2021, and see a strong possibility of headline inflation rate touching 19.5% in third quarter of 2021 before pressures moderate in fourth quarter, due to relatively stable FX rate, high base effect and a better harvest season.

To the firm, there is strong possibility of a CBN rate hike in May/July, as analyst detailed that they remain bearish on Naira fixed income.

“As noted, the lack of consensus in reaching the status quo outcome at the meeting (three committee members voted to hike the MPR), signals a pivotal shift in the thinking of the committee, in preparation for a more hawkish policy era.

“The latest inflation figure will likely provide policy hawks with a justification to push for a rate hike at subsequent meetings, and we expect them to win the debate either at the May or July MPC meeting, depending on the content of the Q1-2021 gross domestic report (GDP) report”.

Although the CBN has consistently argued that the current inflation shock is solely supply side driven, a look at the performance of monetary aggregates over the last two years may suggest otherwise.

As a result of the extraordinary dovish monetary policy of the CBN and unwinding of its open market operations liability in the last two years, net domestic credit exploded, growing at an annualised rate of 24.2% between December 2018 and 2020.

“This was mainly driven by aggressive domestic government borrowing (59.7%), most of which was monetised by the CBN, while private sector credit growth also grew at 15.2% annualised”, Chapel Hill Denham said in the report.

It added that having achieved its objective of unwinding its open market operations liability, analysts believe that the CBN will be looking to curb the growth in monetary aggregate with a tighter monetary framework in the near term.

Analysts explained that the CBN has already signaled its renewed hawkish bias in recent months via balance sheet policies, such as issuance of Special bills, cash reserve requirements debit, and increase in the one-year open market operations stop rate to 10.10% from 6.75%.

These have fuelled a sharp upward reversal of interest rates over the last five months. The benchmark yield curve has trended higher by an average of 700bps since December 2020, with the long end of the curve now trading above 13%.

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Also, the bellwether one-year Treasury Bills auction stop rate cleared at 9% at the auction last week, up from a record low of 0.15% in November 2020. Despite the recent repricing, analysts noted that real yields remain deeply negative and way below long-run level.

“With inflationary pressures likely to remain elevated over the near term, amid large fiscal and external sector imbalances, we expect to see further repricing of yields in the short to medium term, with the 10-year bond likely to breach 14% before stabilising”, Chapel Hill Denham stated.

Inflation Threat: Analysts Predict Policy Rate Hike