Current interest rates depend on expected inflation rates, not prevailing ones: CBE

Hossam Mounir
11 Min Read

The Monetary Policy Committee (MPC) of the Central Bank of Egypt (CBE) decided, in its meeting Thursday, to maintain its basic interest rates at 11.25% for deposit, 12.25% for lending, and 11.75% for the credit and discount rate and the price of the main operation of CBE.

In its resolution accompanying this decision, the Committee said: “At the global level, global economic activity has seen a slowdown as a result of the continuing Russian-Ukrainian crisis.” The trade sanctions imposed on Russia and the resulting bottlenecks in the supply and supply chains have led to an increase in world prices of basic commodities, as well as prices, as central banks abroad continued to tighten monetary policies by raising interest rates and reducing asset purchase programs, to contain high inflation rates in their countries. Moreover, the recently imposed closure in China has raised concerns about the potential to exacerbate disruptions to global supply chains.

“Initial data indicate that domestic economic activity continued to recover during the first quarter of 2022, albeit at a slower pace, as real GDP recorded a growth rate of 5.4% compared to 8.3% during the fourth quarter of 2021. This slowdown is due to several factors, most notably the repercussions of the Russian-Ukrainian crisis, in addition to the fading of the positive impact of the base period, which lasted during the past nine months,” said the MPC.

The committee expects economic activity to witness lower growth rates than previously expected, partly due to the negative repercussions of the Russian-Ukrainian crisis.

With regard to the labour market, the committee indicated a decrease in the unemployment rate in the first quarter of 2022, recording 7.2%, attributing this decrease to the increase in employment rates, which in turn limited the increase in the labor force.

The committee pointed out that the annual rate of general urban inflation continued to rise, but at a slower pace, to record 13.5% in May 2022 from 13.1% in the previous month. It pointed out that the annual rate of core inflation, which does not include fresh vegetables and fruits, goods and services whose prices are set administratively have seen an increase at a slower pace for the second month in a row, and continued the upward trend to record 13.3% in May 2022 from 11.9% in the previous month.

The committee attributed the rise in the annual general inflation rate to the rise in the prices of non-food commodities, as the annual inflation of food commodities slowed for the first time since the beginning of the year, supported by the fading of the supply shock experienced in the previous months in some fresh vegetables.

It added that inflation developments in May 2022 continued to be affected by developments in the Egyptian pound exchange rate, as well as the repercussions of the Russian-Ukrainian crisis on commodity prices.

The MPC considers that the global developments resulting from the Russian and Ukrainian crises are primary supply shocks outside the scope of monetary policy action, although those shocks may lead to exceeding the previously announced inflation targets.

She emphasized that monetary policy tools are used to control inflation expectations, reduce inflationary pressures from the demand side and the secondary effects of supply shocks, which may lead to relatively higher inflation rates than the targeted inflation rates.

“Given the current initial supply shocks, inflation rates may deviate relatively from the central bank’s target inflation rate of 7% (±2%) on average during the fourth quarter of 2022, provided that it will gradually decline after that,” it said.

The committee confirmed that it will continue to assess the impact of its decisions on inflation expectations and macroeconomic developments in the medium term, taking into account the decisions during the previous two meetings to raise basic interest rates. It noted that achieving low and stable inflation rates in the medium term is a prerequisite to support the purchasing power of the Egyptian citizen and achieve high and sustainable growth rates.

The Committee also emphasizes that the current interest rates depend mainly on the expected inflation rates and not the prevailing rates, and that the Committee will closely follow all economic developments and will not hesitate to adjust its policy to achieve the goal of price stability in the medium term.

It is noteworthy that the MPC’s decision to fix the interest rate was widely expected, after the two consecutive rate increases in March of 1% and May of 2%.

Experts and bankers emphasized that the CBE was not obliged to change the interest rate this time because it took proactive steps to confront inflation, and succeeded in them and achieved positive results.

Tamer Youssef, head of the treasury sector at one of the foreign banks operating in the Egyptian market, said that the decision of MPC to fix the interest rate reaffirms the stability of economic conditions and the Egyptian pound’s preservation of its competitive position against foreign currencies, especially that the interest difference between it and foreign currencies is still in its favour.

He explained that the decision to fix the interest was expected. “What we are witnessing in terms of the rise in prices is a direct result of external reasons, so the successive increase in the interest rate will not have the effect of containing inflation rates, and that reducing the money supply in the market by raising interest rates could have negative effects on growth rates in light of the slowdown in the global economy.

Sahar El-Damaty, a banking expert, also confirmed that the CBE was not obliged to increase the interest rate again because it took proactive steps earlier. She noted that central banks in the Gulf tended to increase the interest rate after the change in the United States, due to the Gulf currencies being connected to the dollar, while the Egyptian pound is connected to several currencies.

She explained that the US Federal Reserve raised the interest rate by 1.5% over the past period, while the CBE took strong proactive steps by raising the interest rate by 3%.

She added that the difference between the interest on the Egyptian pound and the US dollar is very large, and therefore encourages investment in the Egyptian pound, which gives a kind of reassurance in the coming period.

She pointed out that Egyptian banks offered high returns on savings certificates, pointing out that the increase in interest leads to an economic slowdown, an increase in costs to industry, and an increase in food prices, and that raising the interest by 1% increases the budget deficit by about EGP 30bn.

She explained that the majority of the hot money represented in foreign investments in treasury bills have already exited, and therefore there is no need to raise interest, explaining that despite the 13.5% urban inflation rate, there are certificates with a return of 14% and 15% in the market, which excludes an increase in interest. El-Damaty stressed that these certificates are considered a safe way to attract savings of individuals and protect them from inflation.

She stressed that the return of dollarization is completely excluded with the high interest rate on the Egyptian pound and saving certificates in the local currency. She noted that MPC takes into account internal and external conditions and variables before issuing its decision on interest rates.

 The decision to fix the interest rate on the CBE’s part also came in line with the expectations of HC Securities and Investment, which expected CBE to keep the interest rate unchanged at its meeting on Thursday.

“We believe that further rate increases will not prove effective in fighting inflation and could backfire by dampening production, leading to further supply shortfalls,” said Monette Doss, HC Securities’ senior macroeconomic and financial services analyst.

She added: “Inflation came in below our expectations at 14% on an annual basis and we expect average inflation at 14.4% over the remainder of the year, which is higher than the target by the CBE at 7% +/-2% for the fourth quarter of 2022. It is affected, to a large extent, by the foreign situation reflecting some shortages in products due to the lack of local manufacturing and low imports”.

She added that the Purchasing Managers’ Index in Egypt was at 47.0 in May, as data indicates a decline in consumer spending, a decline in the volumes of new supply orders at the fastest pace since 2020, and a decline in demand for production inputs as well as the rate of employment and employment.

Beltone Financial also expected interest rates to be fixed during the meeting.

The company’s research department said, in a research note, that it believes that the full impact of raising interest rates on inflation will take time to fully reflect, expecting CBE to keep interest rates unchanged during Thursday’s meeting, to control inflation rates, with the state of instability the world is currently witnessing.


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