In recent days, questions have circulated widely in economic circles and among the Egyptian public about the state of the economy, particularly after inflation rose in February and fuel prices were increased recently, and what these developments may mean for the exchange rate and interest rates. Daily News Egypt put these questions to well-known banking expert Mohamed Abdel Aal.
Why did inflation rise in February?
The increase in inflation in February was partly expected due to the seasonal rise in demand ahead of Ramadan and the holiday period.
During this time each year, consumer spending increases, particularly on items such as clothing, footwear, food, restaurant services and other consumer services.
What was somewhat surprising, however, was that the monthly inflation rate exceeded expectations. Forecasts had suggested a rise of between 1.5% and 2% month-on-month, but the actual figure came in higher, at around 3%.
This is significant because monthly inflation reflects current price dynamics, rather than simply the base effect from the previous year.
What impact will higher fuel prices have on inflation?
Fuel price increases of between 14% and 17% represent what economists describe as a cost shock, the impact of which typically unfolds in three stages.
The first stage appears quickly in transportation and logistics costs. The second stage affects industrial production costs, including building materials and intermediate goods. The third stage eventually feeds into food prices and consumer goods.
Based on previous experiences in Egypt, fuel price adjustments have generally added between two and three percentage points to annual inflation.
This time, the impact could be slightly higher due to two additional factors: elevated global oil prices and exchange-rate movements.
Do rising fuel and energy prices affect the Egyptian pound?
Yes. Higher global oil prices increase the country’s energy import bill, which in turn raises demand for foreign currency.
Periods of global geopolitical tension can also prompt some foreign investors to temporarily withdraw funds from emerging markets, often referred to as “hot money”, which may place additional pressure on the foreign-exchange market.
At the same time, the Egyptian economy still has several stabilising buffers, including foreign-currency reserves, the surplus in net foreign assets within the banking system, and the Central Bank’s liquidity-management tools.
Could the Central Bank raise interest rates at its next meeting?
At present, the most likely scenario is caution, with interest rates remaining unchanged for the time being.
The main reason is that the current inflationary pressures are largely driven by higher global energy prices—an external factor that cannot be fully addressed through interest-rate increases alone.
Nevertheless, the Central Bank continues to monitor several key indicators, including inflation trends in the coming months, movements in the exchange rate, and developments in global oil prices. If these pressures persist for an extended period, a rate hike could become a possible option.
What happens if the war continues and oil prices rise further?
If the crisis continues for a prolonged period and oil prices climb to levels such as $110 or $120 per barrel, this could lead to higher inflation and increased pressure on the exchange rate.
Under such circumstances, monetary policy may need to adopt a more hawkish stance, potentially including interest-rate increases.
However, such decisions carry economic costs, as higher interest rates also raise borrowing costs, increase debt-servicing burdens and elevate financing costs for businesses.
Is there a contradiction between government decisions and Central Bank policy?
This question is often raised.
During periods of global crises or geopolitical conflict, governments typically resort to what is known as crisis-management or shock-management policies.
The government may take fiscal measures, such as adjusting fuel prices or supporting specific sectors, while the Central Bank uses monetary policy to contain inflation and safeguard currency stability.
These policies are not contradictory. Rather, they represent different tools used to manage the same economic challenges, and there is ongoing coordination between fiscal and monetary authorities.
What are the possible scenarios for the US dollar in the coming period?
It is difficult to predict a specific exchange rate for the dollar, as it depends on several factors simultaneously.
These include global oil prices, foreign investment flows, geopolitical developments in the region, tourism revenues and remittances from Egyptians working abroad.
However, it is possible to outline potential ranges under different scenarios.
If global conditions improve and oil prices decline, the exchange rate could stabilise around EGP 50-52 per dollar, which currently appears to be the most likely scenario.
If tensions persist for longer, the rate could move within a broader range of EGP 52-55 per dollar.
In the event of a significant escalation in the crisis and a sharp surge in oil prices, the market could face greater temporary pressure, potentially pushing the exchange rate towards EGP 55-57 per dollar before stabilising.
What is important is that the exchange rate has become more flexible in recent years under the flexible exchange-rate regime, allowing external shocks to be absorbed gradually without depleting foreign-currency reserves or returning to parallel-market conditions.
Could an outflow of hot money trigger an exchange-rate crisis?
“Hot money” refers to short-term foreign investments in debt instruments such as Treasury bills and government bonds.
These funds tend to move quickly between markets depending on global risk levels and expected returns. During periods of global uncertainty, some of these investments may exit emerging markets.
However, several factors help mitigate potential pressure, including the Central Bank’s foreign-currency reserves, tourism revenues, remittances from Egyptians abroad and foreign direct investment in key sectors.
Therefore, the exit of some of these funds does not necessarily signal a crisis. In most cases, it reflects temporary adjustments linked to global market conditions.
What are the likely interest-rate scenarios in the coming period?
Three main scenarios can be envisaged.
The first is maintaining current interest rates, which is currently the most likely outcome at the Central Bank’s next meeting in April. In this case, rates could remain near current levels, with the possibility of gradually returning to a rate-cutting cycle later if inflationary pressures ease.
The second scenario is postponing interest-rate cuts. Prior to the current geopolitical tensions, the expected trajectory was for gradual rate reductions during the year. However, higher energy prices may prompt the Central Bank to delay such cuts until the outlook becomes clearer.
The third scenario is a limited interest-rate increase. If pressures persist for a prolonged period and inflation rises significantly, the Central Bank could raise rates by around 1-2% as a precautionary measure to support price stability and the foreign-exchange market. At present, however, this remains the least likely scenario.
Could the Central Bank hold an extraordinary meeting to raise rates? And could the reserve requirement be increased again?
In theory, the Monetary Policy Committee can hold an extraordinary meeting if major developments occur in financial markets.
However, central banks typically prefer to wait for their scheduled meetings, when more comprehensive data on inflation and market conditions becomes available.
Regarding the reserve requirement ratio, it was previously reduced from 18% to the current 16% in order to provide additional liquidity to the banking sector.
The Central Bank could potentially use this tool again if it seeks to reduce liquidity in the market. However, such a step would depend on a broad assessment of monetary conditions and inflation trends. In my view, this would only occur in exceptional circumstances and over a longer time horizon.
In other words, any decision will depend on developments in inflation, market liquidity and exchange-rate stability.
Conclusion
Overall, the current pressures on the Egyptian economy appear to be driven primarily by external factors, particularly global energy prices and geopolitical developments. As a result, the trajectory of monetary policy in the coming period will remain closely tied to developments in global markets and oil prices.
