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Sunday, 27 September 2020

Against expectations, Central Bank of Egypt cuts interest rates by 50 bps

Central Bank of Egypt surprises with first rate cut since March: The Central Bank of Egypt (CBE) cut interest rates by 50 bps on Thursday — the first since the emergency 300 bps rate cut in March, the central bank said in a statement (pdf).

The move was a surprise to most: All 11 economists and analysts we surveyed last week predicted the bank would leave rates unchanged to support the EGP and the all-important carry trade. In a research note out late last Wednesday, Arqaam Capital suggested however that there was a “decent chance” for a small rate cut as Egypt’s carry trade has been one of the most profitable among emerging markets for the carry trade, with double the risk-adjusted return on one-year t-bills offered by its EM peers.

Where rates stand now: The CBE’s overnight deposit rate is now at 8.75% and the lending rate is 9.75%. The main operation and discount rates are now at 9.25%.

Low inflation paves the way: “As incoming data continues to confirm the moderation of inflation expectations, the reduction of policy rates in today’s Monetary Policy Committee (MPC) meeting provides appropriate support to economic activity, while remaining consistent with achieving price stability over the medium-term,” the central bank said. Annual headline urban inflation decelerated to a 10-month low of 3.4% in August, while preliminary figures show real GDP growth in FY2019-2020 came in at 3.5%, the central bank said. Despite unemployment rising to a two-year high in 2Q2020, the bank sees “a gradual recovery in economic activity,” as indicated by key economic indicators stabilizing in July and August.

The CBE now expects inflation to fall on the lower end of its 6-12% target range in 4Q2020. Renaissance Capital had expected as much, saying in a research note earlier this month that inflation is expected to close out the year just below the inner band target, thanks to muted consumer demand. The firm had expected the CBE to take “measures” to nudge inflation up to remain within the targeted range, suggesting that one possible route would be canceling the 15% high-yielding certificates of deposit — a prophecy that was realized last week.

The decision to move towards monetary easing suggests that the CBE is not concerned about spooking the carry trade, Arqaam’s Noaman Khalid told Reuters. Foreign liquidity is also “relatively stable,” Beltone Financial said in a research note on Thursday. Remittances from Egyptians working abroad rose 11% in July against expectations, which has helped provide FX support amid low revenues from tourism and exports.

Pushing back on the EGP? “The central bank may have also wanted to push back against the recent appreciation of the EGP,” Capital Economics’ James Swanston wrote, noting that the EGP has appreciated by 1% against the greenback since the last MPC meeting.

A rate cut could also help spur capex borrowing and generally be “good news for businesses in terms of liquidity, which has been quite tight since the pandemic,” Naeem Brokerage’s director of research Allen Sandeep told Bloomberg. Our 2020 reader poll earlier this year had suggested that 46% of you wanted to see interest rates fall to around their current levels to unlock capex spending, but private demand growth is now the key to encourage capex borrowing, Beltone said.

Could we see more rate cuts? It’s unlikely in the short term, says EFG Hermes’ head of macroeconomic research Mohamed Abu Basha. While there’s room for more monetary easing, Abu Basha says the “uncertain external environment” makes it improbable that the CBE will push more cuts soon. Swanston thinks that the central bank will “remain cautious” in the months ahead, but is now forecasting rates to fall to 7% by the end of next year.

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