May 2021 Inflation- Base effects ease pricing pressures

What shaped the past week?

Global: Global investors traded softly in the past week as economies continue to open up and travel restrictions continue to ease. Asian markets closed out higher on the Bank of Japan’s decision to keep interest rates unchanged. Japan’s Nikkei stood flat while the schezen and Kospi composites were up by 0.17% and 0.12% respectively. Meanwhile, the Shanghai composite lost 0.5%. Moving to the European market, trading in the region was mixed on the back of the recently released economic data, as well as the Fed reserve rate hike forecast. The German DAX lost 0.07%, while the FTSE100 was down 0.17% at the start of the trading session. The feds comment on a stronger than anticipated inflation trend, and the indication that it may raise interest rates twice in 2023 largely influenced cautious trading in the US markets. As at the time of writing, the Dow jones industrial average as well as the S&P 500 were down by 4.12% and 0.57% respectively, whilst the NASDAQ was up 0.64%.

Domestic Economy: For the second time in a row, base effects subdued inflationary pressures as headline inflation moderated to 17.93% y/y in May. Pressures on the food segment also softened as food inflation eased to 22.28% y/y. This is largely attributed to high base effects and waning food supply shocks. The core segment sustained its ascent to 13.15% y/y, buoyed by low base effects from PMS pump price reductions in May’20 as well as higher FX pressures. Going forward, we see the increased volatility in the Naira spurring core inflation in June despite the marginal gains from CBN interventions. In addition, food and headline inflation could continually ease on the back of high base effects.

Equities: Local equities closed lower w/w, easing 130bps to close at 38648.91pts. Losses were concentrated in the Industrial Goods space, which fell 6bps w/w; as losses in WAPCO (-95bps w/w) weighed on the sector. Meanwhile, all other sectors closed higher with the Banking Sector (+108bps w/w) leading the way. Gains in ACCESS (+427bps w/w), UBA (+210bps w/w) and ZENITBANK (+281bps w/w) helped offset losses in GUARANTY (-121bps w/w), propelling the sector higher. The Oil and Gas sector (+105bps w/w) was the next best performer driven by gains in SEPLAT (+145bps w/w). Finally, the Consumer Goods space saw moderate gains across leading to a 25bps rise w/w for the sector. For the week, traded decreased 7.27% w/w while value traded dropped 27.59% w/w.

Fixed Income: The fixed income market traded in a positive manner this week, as investors remain buy-side driven across the OMO and Bonds segments of the space. The yield across benchmark bonds eased 4bps w/w on average, due to interest across the bonds curve. Meanwhile, in the OMO space yields rose 1bp on average, as the bears and bulls tussled for control during the week. Finally, limited interest across the NTB space, saw yields close flat w/w.. Currency: The Naira depreciated N0.2 w/w at the I&E FX Window to close at N411.00 and while closing flat w/w at 495.00 against the dollar in the parallel market. What will shape markets

in the coming week?

Equity Market: After consecutive sessions of positive closes, we foresee investors coming in to the market to sell on Monday. Thus, we expect a bearish session.

Fixed Income: In the coming week, we expect a quiet trading session to start the week, as investors turn their attention to the forthcoming bonds auction. Similarly, we expect the NTB and OMO spaces to trade in a tepid manner, given constrained system liquidity..

Currency: We expect the naira to remain largely stable across the various windows of the currency space as the CBN maintains interventions in the FX market.

Focus for the week

May 2021 Inflation- Base effects ease pricing pressures Headline inflation moderated for the second time in a row to 17.93% y/y (Vetiva: 18.85% y/y). While this seems contrary to anecdotal evidence, we believe the high base effect was the primary driver of the moderation in the headline figure, as the reopening of economy, restoration of supply chains and reopening of the land borders eased pressure on the headline figure. On a monthon-month basis however, headline inflation rose at a faster pace by 1.01% m/m (Apr’21: 0.97% m/m).

Food prices rise at a slower pace.

Although food inflation eased to 22.28% y/y (Vetiva: 22.78% y/y) from 22.72% y/y in Apr’21, insecurity in foodproducing regions continues to take its toll on food prices, as food inflation (May’21: 1.05% m/m) rose at a fastvolume er pace month-on-month (Apr’21: 0.99% m/m). The major driver of food inflation remains the food and nonalcoholic beverage segment, which is mostly affected by insecurity, adverse weather conditions, and higher pump prices.

Amid the reduction in food inflation, imported food inflation sustained its upward momentum to 16.97% y/y (Apr’21: 16.91% y/y) reflecting the passthrough effects of a weaker Naira and FX restrictions on food imports.

Structural headwinds squeeze core prices.

Non-edible items are still reeling from pandemic-induced disruptions and structural factors (pump price adjustments and dual currency adjustments). This is evident in May’s core inflation outcome – 13.15% y/y (Vetiva: 12.78% y/y). While health and transport inflation lead the pack, we witnessed a moderation in both health (-5bps) and energy (-2bps) inflation for the first time since the pandemic struck. We also attribute this to base effects, given the absence of severe waves of the virus, reduction of PMS prices in Apr’20 and relatively flat PMS prices this year.

In June, headline inflation could ease further, as base effects come to play. Notwithstanding, we note possible headwinds from the adoption of the Nigerian Autonomous Foreign Exchange (NAFEX) rate as the official exchange rate and the consequent impact on the parallel market. Nonetheless, we pen down a higher m/m print of 1.12% y/y for the month of June (May’21: 1.01% m/m) which translates to a headline inflation expectation of 17.82% y/y for the ongoing month. Having adjusted our expectations for the outer months, we now anticipate an average inflation reading of 17.34% y/y for 2021 (2020: 13.25% y/y).

FX Reforms to intensify core inflationary pressures.

While food inflation has moderated, the Onion Producers and Marketers Association of Nigeria is mulling over stripping the southern region of access to onions. While this shock is not broad-based, the resurgence of a food blockade across other key food items could have dire consequences for food inflation, especially if such threats re-emerge close to the harvest season. While we expect prompt intervention to subdue this risk, high base effects could influence a further decline in food inflation to 21.79% y/y in June. Going forward, we note headwinds from the proposed addition of wheat and sugar to the restriction list and tailwinds from the reopening of the borders. Thus, we expect an average food inflation outcome of 21.11% y/y in 2021 (2020: 16.11% y/y).

With new FX pressures on the scene, core prices could remain elevated in the near term as the Naira slips below $500/$ in the parallel market. Thus, we envisage a sustained rise in core inflation to 13.36% y/y in June. This translates to an average core inflation outcome of 13.05% y/y for 2021 (2020: 10.29% y/y).

Whilst reasonable care has been taken in preparing this document to ensure the accuracy of facts stated herein and that the ratings, forecasts, estimates and opinions also contained herein are objective, reasonable and fair, no responsibility or liability is accepted either by Vetiva Capital Management Limited or any of its employees for any error of fact or opinion expressed herein.