May 2023 Inflation – Energy and FX reforms to push inflation higher in June

What shaped the past week?

Global: US stock market indexes had a positive week, driven by the Federal Reserve’s interest rate decision and updates on inflation. Investor optimism grew as the Fed hinted at a possible pause in rate hikes. The week witnessed mixed performance and a significant surge in Wall Street indexes. Economic data showed a rise in retail sales for May, while initial jobless claims remained unchanged.

In the Asia-Pacific region, stock equities experienced a bullish week, influenced by central bank meetings and notable investments in electric vehicle factories. Anticipation surrounded the US Federal Reserve’s monetary policy decision, and market sentiment was impacted by US inflation data. China’s retail sales, industrial production, and Japan’s exports contributed to overall gains.

European stock market indexes had a positive trading week, influenced by key data releases and central bank decisions. Investors closely monitored inflation reports, unemployment rates, and the European Central Bank’s monetary policy decision. Market sentiment fluctuated as inflation showed signs of deceleration, and the ECB hinted at future rate increases.

Domestic Economy: This week, we witnessed significant developments in the domestic economy, ranging from the appointment of an Acting CBN Governor to the unification of foreign exchange rates, and the release of May inflation figures. Following the departure of the second-longest serving CBN Governor, Godwin Emefiele, the President appointed Folashodun Shonubi as the interim governor of the Central Bank of Nigeria. Shonubi had previously held the position of Deputy CBN Governor responsible for operations. Subsequently, the CBN implemented operational changes in the foreign exchange market. To achieve the goal of unifying the foreign exchange markets, all segments of the FX market were consolidated into the Investors & Exporters window. Transactions within this window now follow a “willing buyer, willing seller” approach, effectively ending the multiple FX regime and pegging of exchange rates. As a result, the official exchange rate experienced a significant downward adjustment of 37%, reaching N633/$ on June 14 2023, narrowing the FX gap from 65% to 20%. We believe this adjustment reflects the new calculation of the operational rate for government-related transactions, which is determined as the weighted average rate of the previous day’s executed transactions at the I&E window. Consequently, these measures are expected to bolster government revenue, FAAC allocations, and inflation.

Equities: Nigerian equities witnessed another bullish week of trading, driven by significant administrative actions taken by the Federal Government. Local investors welcomed the removal of the exchange rate peg, resulting in most sectors closing with gains week over week. The VET30 ETF also experienced strong investor demand, rising by 4.51% during the week and achieving an impressive year-to-date performance of 10.76%. The oil marketing sector continued to garner increasing investor optimism, as evidenced by TOTAL’s remarkable surge of 20.38% to close at ₦336.7/share. In the banking space, ETI and STANBIC recorded gains of 21.03% and 20.00% respectively. Additionally, positive sentiment extended to the telecoms sector, with MTNN and AIRTELAFRI experiencing notable surges of 9.60% and 7.78% respectively.

Fixed Income: The secondary bond market witnessed mixed investor sentiment this week, with a prevailing cautious stance among bond investors. Benchmark yields saw a slight increase, with an average uptick of 2bps w/w. In the Nigerian Treasury Bills (NTB) space, investors remained on the sidelines, eagerly awaiting the results of the NTB auction to gain insights into future rate movements. Consequently, yields in the NTB space closed unchanged w/w.

What will shape markets in the coming week?

Equity market: Market yearns for its next positive driver, as investors continue to mull over the latest inflation data from the NBS. We expect mixed trading next week, with a likely decline in the average traded volume for the week.

Fixed Income: We expect the market to trade in a muted manner on Monday as investor focus shifts to the bond auction slated for said day. Meanwhile, the NTB space should trade in line with liquidity levels and the NTB auction results from the past week.

May 2023 Inflation –  Energy and FX reforms to push inflation higher in June   

According to National Bureau of Statistics data, headline inflation increased to 22.41% y/y in May (Vetiva: 22.45% y/y). The surge was driven by broad-based increases in food and core segments. Headline inflation increased to 1.94% m/m (Apr’23: 1.91% m/m), driven primarily by higher energy prices. However, we note that these figures do not yet capture the reforms announced by the new administration.

Food inflation rises to new 18-year high

Food inflation nudged 21bps higher 24.82% y/y in May (Apr’23: 24.61% y/y), its highest since March 2005. The increase was driven by elevated processed and farmgate prices. On a month-on-month basis, food inflation rose to 2.19% m/m in May (Apr’23: 2.13% m/m) amid high transport prices.

Core inflation eases slightly in May

Core inflation declined to 20.06% y/y (Apr’23: 20.14% y/y) on account of high base effects. On a month-on-month basis, core inflation rose to 1.81% in May (Mar’23: 1.46% m/m).

Subsidy removal and FX unification will send inflation to new highs

On the 29th of May, the 16th President of Nigeria, Bola Ahmed Tinubu, announced the full removal of subsidies. We expect the full impact of that decision to reflect from the month of June. Thus, we expect headline inflation to rise by 3.25% m/m and 24.14% y/y in June.

Subsequently, the Central Bank of Nigeria decided to float the Naira. Although most commodities are priced based on the realities in the parallel market, the deregulation in the downstream sector implies NNPC will no longer be the sole importer of PMS and thus, PMS prices would be based on near parallel-market levels. Through the energy channel, higher transportation costs, and eventually, much higher commodity prices could raise consumer price inflation in outer months. As a result, we raise our full-year headline inflation forecast to 25.9% y/y in 2023 (2022: 18.76% y/y).