In a second surprise move in a row, the Central Bank of Egypt (CBE) raised key interest rates by another 200 basis points (two per cent) on Thursday. After an unexpected two per cent rate hike on 21 May, the CBE raised the overnight deposit rate to 18.75 per cent from 16.75 per cent and the overnight lending rate to 19.75 from 17.75 per cent. The move was not anticipated by most analysts who had predicted that the CBE would leave rates unchanged, given the cooling off in inflation which dropped from a 30-year high of 31.5 per cent year-on-year in April to 29.8 per cent in June. However, inflation is expected to rise over the coming months after the government's decision to slash energy and fuel subsidies as part of its ongoing economic reform programme. Last week, the government increased electricity prices by up to 42 per cent this fiscal year for households and a week earlier it raised fuel prices by up to 50 per cent. Concerns over the inflation outlook have prompted the CBE to raise interest rates, but at the same time it has hinted that this latest rate hike is likely to be the last in the tightening cycle, London-based macroeconomic research group Capital Economics said in a research note. It estimates that the recent subsidy cuts will directly add 1.5 per cent to the headline inflation rate, but it expects that this will drop sharply towards the end of this year, close to the CBE's end of 2018 target of 13 per cent. “This is likely to prompt the Central Bank to start cutting rates, and we envisage a prolonged easing cycle over the next couple of years. We are sticking to our forecast for the overnight deposit rate to fall to 12.75 per cent by the end of 2018,” Capital Economics said. While the CBE defended its decision as a way of curbing inflation, some economists argued that the move would have a limited impact on curbing cost-driven inflation triggered by higher production costs rather than an increase in demand. Economist Esraa Ahmed of Mubasher International, a financial services firm, said in a research note that the recent interest rate hikes were “unjustifiable” and would hardly affect inflation as this was mainly cost-driven. She said that higher rates on savings would not offset the inflationary impact of fuel subsidy cuts, electricity price hikes, and a higher rate of value-added tax (VAT). “We expect year-on-year inflation to hit 35 per cent on average in the first quarter of 2017/18. However, a favourable base effect may be more powerful in easing inflation rates afterwards,” Ahmed said. She added that one main concern coming out of the rate hike was higher pressure on the fiscal front, as current monetary policy is running counter to the announced fiscal reform programme. Citing interest payments increases, and assuming the CBE would decrease current rates by at least one to two per cent by 2018, Mubasher revised its projections for the financial year 2017/2018 budget deficit, raising it from LE418 billion (10.1 per cent of GDP) to around LE431 billion (10.5 per cent of GDP). The impact of the decision on the budget is yet to be felt as the two consecutive increases in base rates this year were not taken into account in the budget for the 2017/2018 fiscal year, Deputy Finance Minister for the treasury Mohamed Moeet told Reuters this week. “We expect the interest rate decision to be a temporary measure to target inflation,” Moeet said. “We expect inflation to fall in early 2018 and thus [can] begin cutting interest rates,” he said. The move has also raised concerns among the business community, as an increase in interest rates means costlier borrowing which will affect private-sector investment because of higher lending rates for investors. This will likely hinder businesses, investment and job creation. But a rate hike will also mean that yields on treasuries rise, which would attract more foreign investment, mostly hot money, to CBE auctions, especially for treasury bills that are more liquid and offer highly attractive rates, Mubasher's Ahmed said. Yields on 182-day bills had almost doubled from 11.82 per cent in February 2016 to 21.15 per cent in July 2017, before the latest rate hike. Last week's strengthening of the Egyptian pound against the dollar was largely attributed to a considerable influx of portfolio investments in government debt instruments. Foreign holdings of Egyptian treasury bills rose to $7.5 billion at the end of May, and CBE Governor Tarek Amer has been reported as saying that raising interest rates would increase hard currency inflows to the banking system. He told the daily Al-Akhbar that some $57 billion had come into the banking system since the floatation of the pound in November 2016. Economists believe that the CBE's decision has been driven by the International Monetary Fund (IMF), which recommends that Egypt focus on bringing down inflation. During the IMF/World Bank spring meetings in Washington in April, IMF Managing Director Christine Lagarde said that there had to be a special focus on inflation as this risk was “weighing on the population”. The IMF further cited the interest rate instrument as the right instrument to use in order to manage inflation down. The market seems to be responding positively to the CBE's message that the move is temporary. The stock market showed little reaction on Sunday to the unexpected interest rate hike, with the main index (EGX30) slipping 0.1 per cent, a far more relaxed reaction than the 2.5 per cent slump that followed the previous rate hike in May.
