More Hikes Ahead For Egypt's Central Bank

Fitch Solutions / Banking & Financial Services / Egypt / Mon 21 Mar, 2022

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Key View

  • We at Fitch Solutions anticipate the Central Bank of Egypt (CBE) will tighten monetary policy by another 100 basis points (bps) by end-2022, after a 100bps hike on March 21.
  • Higher inflation and increased risk-off sentiment towards emerging markets will put downward pressure on the Egyptian pound, providing impetus for the CBE to hike again.
  • Meanwhile, after authorities signaled they would allow more exchange rate flexibility, permitting the exchange rate to sell-off by nearly 14.0% on March 21, we believe further monetary tightening and a new deal with the IMF – which we see as increasingly likely – will limit further downward pressure on the exchange rate.

We at Fitch Solutions anticipate the Central Bank of Egypt (CBE) will continue to hike its benchmark interest rate in the months ahead. In an unscheduled meeting on March 21, the Monetary Policy Committee of the Central Bank of Egypt (CBE) increased the overnight deposit and lending rates by 100 basis points to 9.25% and 10.25%, respectively. This constituted the first hike since June 2017. Despite the surprise timing, the monetary tightening is in line with our view. Prior to Russia’s invasion of Ukraine, we had expected the CBE to hike by 75bps due to more aggressive global monetary tightening and higher inflation, and we revised up our expectations for a 100bps increase following the invasion. Following the CBE’s relatively hawkish policy decision, we now expect another 100bps over the coming months for two key reasons:

More Hikes Likely In 2022

Egypt - Deposit Rate & Lending Rate, %

Source: CBE, Fitch Solutions

Higher-for-longer inflation will provide impetus for the CBE to tighten further this year. The press release accompany the March 21 meeting pointed out that the Russia-Ukraine war had exacerbated inflationary pressures in Egypt, in line with our view. The rally in commodity prices (especially grains and fuel) since Russia’s invasion of Ukraine has already prompted us to revise our average inflation forecast in Egypt from 7.5% to 10.0%, implying that inflation will remain above the CBE’s 5.0-9.0% target band through 2022, and we believe the risks lay to the upside. Given the recent more hawkish rhetoric by the CBE, suggesting a greater willingness to tighten than we had previously expected, we think will the elevated prices will result in further interest hikes.

Higher Inflation In 2022

Egypt – Inflation, y-o-y %

Source: CBE, Fitch Solutions

Against a backdrop of greater risk aversion in global financial markets, we believe the CBE will seek to boost the attractiveness of its real interest rates and bolster portfolio inflows. We had expected that the conflict would exacerbate Egypt’s external vulnerabilities, with higher global commodity prices leading to a wider current account deficit. While Egypt had previously relied on its attractive real interest rates to ensure robust portfolio inflows, using this to fund its current account deficits, a shift toward greater risk aversion in global financial markets alongside higher inflation in Egypt has prompted a reversal in these flows in recent weeks. Indeed, a recent Reuters article estimated portfolio outflows from Egypt at USD3.0bn in early March in the aftermath of Russia’s invasion of Ukraine. We believe this likely prompted the CBE to tighten at its latest meeting. Given a broader shift toward monetary tightening amongst multiple developed and emerging markets, we expect authorities will continue to feel pressure to preserve the attractiveness of Egypt’s real interest rates relative to other emerging market peers.

Tighter monetary policy will help to support the Egyptian pound, after authorities allowed a sharp sell-off on March 21. The CBE had previously been intervening in the exchange rate market, keeping the pound stable at around EGP15.70/USD since September 2020. However, in its March 21 communique the CBE highlighted the “importance of the exchange rate flexibility to act as a shock absorber” for the first time, and allowed the exchange rate to fall to EGP18.22/USD, effectively marking a 13.8% depreciation.  

CBE Adjusts Exchange Rate

Egypt - Exchange Rate, EGP/USD

Source: Bloomberg

Going forward, we see the currency as unlikely to continue its sharp depreciation, after the sell-off brought it more closely in line with its historic real effective exchange rate. Rather, several factors will likely see the exchange rate begin to pare some of its losses in the months ahead. While previously concern over an increasingly overvalued exchange rate had kept investors on the sidelines, in the wake of the sell-off, and alongside signs of a more hawkish bias by the CBE, this could encourage a return of portfolio inflows. Moreover, we believe the decision to allow greater exchange rate flexibility and shift toward tighter monetary policy will likely facilitate an agreement with the IMF that would further reassure investors and boost investment inflows. An agreement with the IMF would also likely unlock additionally bilateral funding, such as deposits from Gulf Cooperation Council countries. As such we now forecast the Egyptian pound will average EGP17.52/USD in 2022, compared to our prior forecast of EGP16.58/USD. Our new forecast implies that the currency will depreciate by 12.0% on average in 2022.  

This report from Fitch Solutions Country Risk & Industry Research is a product of Fitch Solutions Group Ltd, UK Company registration number 08789939 ('FSG'). FSG is an affiliate of Fitch Ratings Inc. ('Fitch Ratings'). FSG is solely responsible for the content of this report, without any input from Fitch Ratings. Copyright © 2021 Fitch Solutions Group Limited. © Fitch Solutions Group Limited All rights reserved. 30 North Colonnade, London E14 5GN, UK.

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