By Babajide Komolafe

Analysts at Financial Derivatives Company have predicted that foreign investors will reduce patronage of FGN Bonds due to decline in interest rates occasioned by low inflation rate.

In a report titled FDC Economic Flash, they noted that with inflation at single digit, the Central Bank of Nigeria (CBN) will have to lower its monetary policy rate, which will prompt decline in interest rate. This they affirmed will cause the exchange rate of the naira go up marginally, and hence reduce foreign investors appetite for government debt instrument.

“The naira may depreciate marginally due to lower interest rates, leading to a reduction in foreign investors’ appetite for government debt instruments and lead to capital flight. With the high external reserves level (currently at $47.3bn), the CBN’s willingness and ability to support the naira could increase in the near term. The strength and direction of the naira against foreign currencies is critical to importers of raw materials, as a weak currency will increase the cost of imported goods and may erode manufacturers’ profits”, the report said.

“In February, the FDC’s Lagos urban inflation rose by 1.39% to 12.77% from 11.38% in January. This increase is mainly attributable to a rise in the prices of a few items with higher weights in the index. The non-food index rose by 1.52% from 7.34% in January due to a significant increase in the price of some building materials and toiletries.

The food basket also trended upward by 0.91% to 11.92 from 10.79% in January. This ends the three-month consecutive decline in the urban food basket. In our opinion, the rise in the food index could be a result of the price increase of items that are out of season such as yam and pepper, and due to a higher import levy on rice.

“In the month of February 2012, consumer prices which had spiraled in January had started moderating. The muted price effect in February last year was due to a combined ef-fect of consumer resistance at the shelf and potential resistance of the demonstrators. The impact of a slower inflation environment in February 2012 reduces the base year effect in 2013, hence the likelihood of this spike.

“We forecast that the official national inflation will inch up marginally to 9.1% (±0.26%) from 9.0% recorded in January. The rise in the national inflation figure correlates with FDC’s urban survey result of an upward movement. From our regression analysis, the consumer price index will increase by 0.42% to 142.5pts in February.”

“The Monetary Policy Committee will meet on March 18th to determine what monetary policy action to employ in a benign inflation environment. The CBN has its work cut out for it, in aligning its mandate for price stability and the public outcry for a cut in interest rates. The clarion call is for the CBN to adopt an accommodative stance.

“There is a disconnect between policy rates and money market rates, as the market rates de-clined by 200bps prior to the inflation report. Due to the benign inflationary outlook, we expect the average Nigerian Inter-Bank Offered Rates (NIBOR) to decline further in March.  This point to the fact that as inflation continues to decline, the market has come to realize that the CBN has limited options on its current conservative stance.

Therefore, a rate cut in March will only formalize market anticipation.”