Historical Inflation Adds to CBN’s Headache, Fuels Fear Factor • MPC Faces ‘Trilemma’of Increasing Inflation, Currency Pressures and Interest Rate Stability

The storm through which the Central Bank of Nigeria (CBN) is paddling is not abating. Just as the apex bank is thinking of ways of resolving the foreign exchange crisis initiated by dwindling oil prices and corruption, inflation rate, the average rate of change in the prices of goods and services keeps inching up steadily.
The worse part of the raging inflation is that, “it is not demand pull but cost-push”, said Bismarck rewane.
He said this higher inflation rate was widely expected, given the prolonged fuel
scarcity and shortage of perishables.
It is important to underscore the impact of this increasing trend in inflation rate on consumer expectations and behavior, whether it is aberrational or consistent.
“The rising inflation is likely to be aberrational but the trend is becoming more consistent and is fueling the fear factor. Anticipated inflation is more important than historical inflation because it influences consumer behaviour and preferences. Demand for goods will increase if people expect prices to rise in the near future.
As demand increases, producers would be forced to increase prices up to a point that there is a struggle of bargaining power. At this level, it is the price elasticity of demand that determines if there would be a further increase in prices. Another threat to inflation is the possibility and timing of the subsidy removal, which is now becoming more inevitable” said Rewane.
Based on the current happenings, the Monetary Policy Committee (MPC) will be in a tight spot
Rewane believes that this increase in the price level will be one of the key considerations at the next Monetary Policy Committee (MPC) meeting on July 23 and 24.
“The MPC is facing the typical monetary policy’ trilemma’ of increasing inflation, currency pressures and interest rate stability. While a decrease in interest rates is politically expedient to stimulate economic growth, it may not be the appropriate move due to currency and inflationary pressures.
“The increased liquidity in the system from the bailout funds is another factor that the CBN would have to consider. The CBN will be reluctant to increase interest rates as monetary policy tightening is almost reaching its upper limit. The CBN could alternatively increase its use of administrative tools such as cash reserve ratio (CRR) and Open Market Operations (OMO).
Even though the CBN is committed to defending the Naira, the currency pressures facing Nigeria are becoming more intense. The spread between the interbank rate and the parallel market creates an arbitrage corridor for speculators, and is now a round tripper’s paradise. Another issue that is of concern is the consistent decline in oil receipts as a result of falling oil prices, when the sanctions on Iran are finally removed.
Inflationary expectations in July and August do not seem like there will be respite soon. For instance, increased demand for fruits during the Ramadan fasting period in July will lead to a seasonal rise in prices. Inflation in the near term will also be affected by the new restrictions in the forex market and the effective depreciation of the Naira. With recent calls for an upward review of the current minimum wage of N18,000, the Nigerian Labor Congress may intensify its demand for an increase in the national minimum wage due to the persistent inflation.
Although the stock market is historically inflation neutral, investors fear that higher inflation will virtually lead to a rise in interest rates and fall in stock prices. They will therefore begin to go short on stocks.
“Thus far, the NSE ASI has returned -9.5 per cent year-to-date (YTD), with inflation-adjusted returns on equities falling from -11.0 per cent in May to -17.1 per cent in June.
The dollar adjusted inflation after considering the depreciation of the naira is – 35.5 per cent. As exchange rate is interest rate driven, the outcome of the MPC meeting will have an effect on the currency.
Many African countries are also facing inflationary pressures. Angola’s inflation rate rose to 9.6 per cent in June 2015 from 8.86 per cent in May. Kenya also witnessed a rise in inflation from 6.87 per cent in May to 7.03 per cent in June 2015, just as Mozambique’s inflation rate rose from 1.29 per cent in May to 1.36 per cent in June 2015.
The central banks of many African countries have taken various steps to curtail the increasing inflation in their respective countries. Most recently, the Central Bank of Kenya raised Central Bank Rate (CBR) by 150 basis points from 10.0 per cent to 11.5 per cent during its July 2015 MPC meeting.
The question is that, what decision will Nigeria’s MPC come out with this week.

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