The Biggest Adjustment in Policy Interest Rates Since 2011

CBE raises key policy rates by 100 basis point

In its meeting held on July 17, 2014, the monetary policy committee (MPC) of the Central Bank of Egypt (CBE) decided to raise all policy rates by 100 basis points. The overnight lending and deposit rates were raised to 10.25% and 9.25%, respectively, and the discount rate was raised to 9.75%. This is the highest increase in policy rates since the CBE raised the discount and overnight deposit rates by 100 basis points in November 2011.

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A preemptive move to anchor inflationary expectations

While most analysts did not expect a change in policy rates, the CBE decided to take a preemptive move in an attempt to anchor inflationary expectations in light of the recent increases in prices of key regulated items like fuel products, electricity and tobacco that are expected to have a notable and swift pass through effect on prices of food items. While inflation rates will inevitably shoot up starting July 2014, the CBE’s efforts aim at keeping inflation relatively tamed to avoid uncontrolled price hikes that would have adverse implications on consumption patterns and investments decisions. While this move might help to slightly anchor expectations and signal the CBE seriousness in using its tool kit to address inflationary expectations, we think it would have negligible impact on actual spot inflation rates that is stemming from supply side (higher cost) rather than reflecting higher domestic demand. In fact, domestic demand is expected to remain muted in light of higher taxation, prices and continued deteriorated labor market conditions.

Implications on the government’s cost of borrowing

Dcode EFC expects the CBE to tighten adopted monetary policy throughout FY 2014/15 amid elevated inflationary expectations. This will directly affect Government domestic cost of borrowing, which would potentially increase relative to rates prevailing in FY 2013/14. However, the recent fiscal consolidation measures taken by the government that are expected to bolster confidence in Egypt’s finances and reduce the perceived risk associated with purchasing and holding government securities would act as a buffer and would keep nominal interest rates in check. It’s worth mentioning that Banque Misr raised its interest rate on three-year CD by 100 bps to 10.5%. Other public and private banks will likely follow soon. Also, the interest rate on 3-month and 9-month T-bills increased by 1.05 PPT and 1.13 PPT, respectively, in the latest auction held on July 20, 2014.

Implications to private investments and consumption

Currently, the main impediment to private investments is the access to credit rather than the cost of borrowing. However, if interest continued their upward path for a prolonged period of time, it can then be embedded in the valuation of investments and hence might lead to a slowdown in new private investments.

Private consumption over the coming year will undoubtedly be affected by the recent monetary and fiscal measures. The anticipated hike in inflation, coupled with the recent increase in interest rates, would both weigh heavily on household consumption, which is expected to slow down in FY 2014/15.

Going forward

While we expect the CBE to generally adopt a tightened monetary policy, we do not foresee in the short term more sharp changes in policy rates especially if the pace of economic recovery continues to be slow and sluggish. The CBE will monitor how markets respond to the recent increases in prices and interest rates. If inflation rates shoot up significantly, the CBE would be inclined to further increase interest rates. However, if inflation rates remained in control (below 15%), the CBE would likely maintain key policy rates at their current levels. Once inflationary pressures start to fade away, interest rate cuts by CBE would be likely to spur private investments and economic growth.