CBE expected to keep interest rates on hold despite subsidy cut



Thu, 06 Jul 2017 - 01:50 GMT


Thu, 06 Jul 2017 - 01:50 GMT

CBE - Flickr/Muhammad Mansour

CBE - Flickr/Muhammad Mansour

CAIRO - 6 July 2017: The Central Bank of Egypt (CBE) is scheduled to consider interest rates today, amid expectations of keeping them unchanged despite the government’s recent decision to slash energy subsidies.

On the eve of the 30 June Revolution’s fourth anniversary, the cabinet introduced new increases to fuel prices and electricity tariffs by up to 50 percent and 40 percent respectively, fueling concerns about more inflationary pressures in the coming months.

Since November, inflation has accelerated in Egypt, where half of the population is living near or below the poverty line, to the highest level in decades on the back of the Egyptian pound's flotation, introduction of the Value Added Tax (VAT) and subsidy cuts.

All these measures were necessary for Cairo to clinch a $12 billion three-year loan agreement with the International Monetary Fund (IMF).

Four leading investment banks and think tanks agreed that the CBE will keep the policy rates unchanged. Economists argue that raising the interest rates would not be effective anymore in containing an inflation that is triggered by higher production costs, after the local currency’s float along with other reforms, and not by an increase in demand.

"Inflation could rise to around 35 percent as the simultaneous impacts of the one percent VAT increase, energy hikes, and re-pricing of government services take their toll on the summer months,” Dubai- based investment bank Arqam Capital said in a research paper.

To tame the soaring inflation, the CBE’s Monetary Policy Committee (MPC) decided in its last meeting on May 21, to increase the overnight deposit and lending rates by 200 basis points from 14.75 percent to 16.75 percent, and from 15.75 percent to 17.75 percent, respectively. This was the first action since the 300 bps hike on the same day of the pound's float in November.

This recent decision came in line with the International Monetary Fund’s (IMF) demands to hike the interest rates in order to curb the skyrocketing inflation and mitigate public anger.
Arqam Capital raised its inflation forecasts for the financial year FY 2017/2018 (July-June) to 27 percent, however, it ruled out a rate hike in today's meeting after the recent hike of 200bps.

Potential rate cuts will likely be delayed to the first half of next year when average monthly inflation rates decline to normal levels (below 1.25 percent), the report read.
Beltone Financial also ruled out a rate hike, while it predicted a potential rate cut during the first quarter of 2018 as it forecasts inflation to ease boosted by the pound’s correction against the USD.

Beltone expects annual inflation to drop to 10.2 percent during the first half of 2018, down from 30.2 percent in the second half of 2017.

Pharos Holding also predicts the CBE to keep policy rates unchanged, with a possibility of another short-term rate hike in case of a larger than expected inflationary shock.
"While we reiterate that the first round effect of the energy subsidy cut is inevitable and transitory, the CBE’s recent 200bps interest rate hike will also help absorb the demand-pull second round effects," Pharos Holding Economist Ramy Oraby said.

Implementing the second round of the energy subsidy cut will help lure more foreign direct investment and private domestic investment as it reflects the government's commitment to the moving ahead with the economic reform, said Oraby.

Fuel price hikes will add 1.5 percent to inflation, and this may be boosted as the government also pushed ahead with plans to raise electricity tariffs, London-based think tank Capital Economics’ Middle East economist Jason Tuvey said.

"The trend in inflation over the next 12-18 month will be down. One result of this is that interest rates are likely to be cut, probably around the turn of the year," Tuvey predicted.



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