To Hike or Not to Hike?

Doaa A. Moneim reports on what the Central Bank of Egypt’s Monetary Policy Committee will likely decide on interest rates this week

The Central Bank of Egypt’s Monetary Policy Committee (MPC) is expected to meet on 23 June to review key interest rates at its fourth meeting this year.

Since the onset of the war in Ukraine, the CBE has raised key interest rates by a total of 300 basis points (three per cent) over two consecutive meetings to contain inflationary pressures and achieve price stability over the medium term.

Annual headline inflation recorded a three-year high of 13.5 per cent in May compared to 13.1 per cent in April. Besides seasonal pressures, the inflation rate is being driven by the war in Ukraine and its effect on commodity prices.

Another factor affecting the CBE decisions are the moves made by the US Federal Reserve to raise interest rates to contain inflation in the US. In May, it hiked US interest rates by 50 basis points for the first time since 2000, and on 15 June it raised them again by 75 basis points in a bid to contain 40-year high inflation.

“The US dollar, the slumbering giant, has been awakened by record-breaking inflation rates, driving the Fed to hike interest rates more than initially expected and perhaps inducing a recession in the process to tame inflation,” said a note by investment bank Prime Holding referring to foreign investments in Egypt’s carry trade.

“This will put more pressure on the CBE to bring interest rates up for Egypt to regain its position as an attractive destination for foreign investors looking for decent real interest rates.”

Prime projected the CBE raising key interest rates by a a total of 400 to 450 basis points (four to 4.5 per cent) for the year, including the previous 300 points the CBE has introduced so far.

It said that interest rates are likely to remain the CBE’s main weapon of choice to address ongoing economic challenges, mainly elevated inflation and the rise of the exchange rate of the US dollar against the Egyptian pound.

But Monette Doss, head of macro and financials at investment bank HC Securities and Investment, does not recommend introducing increases to interest rates over the short term.

She said the higher rates would not prove effective in combating inflation and could prove to be self-defeating by suppressing business activity and leading to more supply shortages.

Though higher interest rates are important for the carry trade, there are other factors that would prevent them from realising that target, she said.

The carry trade is essential for supporting Egypt’s net international reserves (NIR) given their recent decline to $35.5 billion in May from $40.9 billion in February, she pointed out.

However, she added, an overvalued pound, as indicated by the JP Morgan real effective exchange rate index, the change in outlook on the Egyptian economy to negative from stable by the ratings agency Moody’s, the emerging markets sell-off, and a subdued increase in 12-month treasury bills are hindering the carry trade and diluting the benefits of an interest rate hike, Doss explained.

The ratings agency Fitch Solutions downgraded Egypt’s real GDP growth for the upcoming fiscal year 2022-2023 — to be rolled out on 1 July — to 4.9 per cent on Sunday, down from the 5.5 per cent it had initially projected, mainly driven by the fallout from the Russian-Ukrainian conflict that will affect Egypt in terms of higher commodity prices, disruptions to wheat supply, lower tourist inflows, and increased risk-aversion towards emerging markets.

“Soaring inflation and monetary tightening will weigh on private consumption, while a rising subsidy bill and debt-servicing costs will force reductions in capital expenditure,” Fitch noted.

Going forward, banking expert Hani Abul-Fotouh expected Egypt’s inflation to rise, mainly because of the Ukrainian war, before stabilising in the fourth quarter of 2022. He expected it to drop incrementally during the first quarter of 2023 to return back to the single digit zone.

“The local market has started to absorb the price hikes and consumers, especially those with fixed incomes, have begun to change their consuming habits and have begun to rationalise,” Abul-Fotouh said.

Through the end of 2022, he expected two per cent interest-rate hikes on the back of continued inflationary pressures and a sustained US Fed tapering policy that boosts the US dollar at the expense of the Egyptian pound.