At first glance one might not see much in common between prices and interest rates, but Niveen Wahish finds out they could not be more correlated Prices have dropped. Not everyone has noticed, perhaps the range of products that have seen a drop is limited though it sure has reflected on the inflation rate. Annual headline CPI inflation fell to 14.3 per cent in January compared to 18 per cent and 20.3 per cent in December and November 2008 respectively. According to Mustafa El-Dawi, head of the Groceries and Food Products Division of the Federation of Chambers of Commerce, prices had been escalating wildly since January 2008, and have only just begun to drop two months ago. This happened because goods coming in from abroad are cheaper. This, El-Dawi said, has forced retailers to cut their prices or risk ending up with expired stock on their hands. He also lamented that so far price reductions have only affected some basic food items such as cooking oil, ghee, rice, sugar and flour. In fact, consumers complain other items which are also important to the family meal such as meat or cheese, are still expensive, let alone the durable goods. But none of this has gone unnoticed. The Central Bank of Egypt (CBE) said in a recent statement: "It is important to emphasise that the sharp retrenchment in international commodity prices, which began in August 2008, has not been fully reflected in domestic price levels due to downward price rigidities in domestic markets." Some stores are able to accommodate the price decreases better than others. Mohamed Kamal, manager of Hyper 1 hypermarket says that superstores are better equipped to offer consumers better prices because of their leverage over producers. Kamal explained that his store services some 10,000 customers per day, which means that it has to procure massive amounts of products. "This enables us to pressure the supplier to lower his margin of profit;" he said, adding that "small retailers have a hard time doing that because of their lower turnover." While consumers may not be satisfied with price declines so far, the CBE has seen that the decline in inflation, which has come on the back of lower prices, was enough to prompt it to reduce interest rates. The CBE had resisted any interest rate cuts for the past few months on the pretext that inflation was high. And even when interest rates started to drop drastically worldwide in the aftermath of the breakout of the financial crisis, the CBE held its breath and kept rates unchanged. However, during its meeting last Thursday the CBE's Monetary Policy Committee decided to cut its overnight deposit and overnight lending rates by 100 basis points (bps) to 10.5 per cent and 12.5 per cent respectively. And the discount rate was also cut by 100 bps to 10.5 per cent per year. A CBE statement also said that "the risks to the domestic inflation outlook are lower in light of the deteriorating prospects for global growth in 2009 and given the sharply declining international commodity prices. Against this background, the MPC judged that a less restrictive monetary policy stance is required, at this juncture, in order to stabilise economic growth around its potential." But not everyone is confident that the CBE needed to take this step at this moment in time. One banker who preferred to remain anonymous would have preferred that the CBE refrain from lowering interest rates just now. It is worth noting that so long as inflation remains higher than interest rates, then it is considered to be a negative interest rate. By doing that, the banker said the CBE has stepped onto a large base of depositors who depend on the interest rate they collect on their deposits for their income. And this, he said, goes against attempts to raise the savings rate. To him a one per cent decrease in interest rates will not make much difference in these stagnant times. And serious businessmen wishing to initiate new start-ups or expansions could have been better encouraged to do so by other initiatives such as that of lowering energy rates, as recently granted to some industries. As for the effect of this rate cut on the stock market, the anonymous banker said, "eight months ago, such a drop in interest rates would have taken the stock market index through the roof." But today, he pointed out, after the losses incurred by many in the stock market in recent months, "many might not have the guts to venture into the stock market before there is a strong signal that it will improve or at least stabilise." But not everyone sees eye to eye with that view. Omar Radwan, executive director of Asset Management, HC Securities and Investment pointed out that the stock market has been reacting very positively to the interest rate cut, especially since it is the first since March 2006. In fact the CASE 30 index, Egypt's benchmark stock index, rose nearly three per cent on Sunday on the back of news of the interest rate cut. In theory, he said, any interest rate cut is positive news for the stock market. It means an increase in the fair value of company shares provided there are no other variables, he explained adding that it also means good news for companies because they will be able to finance any debt at much cheaper rates. To Radwan, the rate cut is "big news and an indication that the CBE is being less restrictive in monetary policy". Radwan is also confident that this cut will not be the last, "there is a trend that financing will be cheaper." In fact the CBE press release indicated that the MPC will continue to take the necessary measures to contain the adverse effects of the global economic turmoil on the domestic economy, provided that they do not conflict with the price stability objective." What Radwan hopes is for banks to respond to this rate cut. "It is time to start looking at the economy and its needs. The banks need to do what they were created for, namely lending, not to take the easy way out and park their money in treasure bills," Radwan said.