Wednesday,19 September, 2018
Current issue | Issue 1301, (23 - 29 June 2016)
Wednesday,19 September, 2018
Issue 1301, (23 - 29 June 2016)

Ahram Weekly

Interest rates upped

Curbing inflation is the main reason behind last week’s hike in interest rates, writes Nesma Nowar

Al-Ahram Weekly

The Central Bank of Egypt (CBE) raised key interest rates by one per cent on Thursday in a move intended to rein in the soaring inflation that hit a seven-year high last month.

The bank raised the overnight deposit rate from 10.75 per cent to 11.75 per cent, its highest level in over a decade, and hiked the overnight lending rate from 11.75 per cent to 12.75 per cent, its highest since 2008.

The discount rate was also raised by one per cent to 12.25 per cent, according to a statement from the CBE’s Monetary Policy Committee (MPC).

The annual inflation rate rose to 12.3 per cent in May 2016 from 10.27 per cent in April, the highest monthly rate since July 2014. Annual core inflation, which strips out items with volatile prices such as fruit and vegetables, jumped to 12.23 per cent last May from 9.5 per cent in the previous month, the highest in seven years.

The MPC attributed the hike in inflation to price adjustments, supply shocks such as the increase in rice prices, seasonal effects of the holy month of Ramadan, and a lagged pass-through effect from the March exchange rate adjustment.

In March, the CBE devalued the Egyptian pound by 14 per cent to LE8.78 per US dollar and raised interest rates by 150 basis points days later to control inflation.

“After evaluating the balance of risks surrounding the inflation outlook to date, the MPC judges that a rate hike is warranted to anchor inflation expectations over the medium term,” the MPC said in a statement. It added that it would continue to closely monitor all economic developments, particularly fiscal policy and its effect on the inflation outlook.

The move came as a surprise to some economists who had predicted that the MPC would maintain interest rates. Others who had predicted a rise were surprised by the extent of the hike.

Economist Mokhtar Al-Sherif said the hike was intended to curb inflation and that such measures have historically been successful in Egypt. He added that despite the negative consequences of such a hike, the CBE had given priority to curbing inflation.

On the flip-side, raising interest rates would increase interest payments for the government, adding more strains to the budget. Economists expect the deficit to be 11 per cent of gross domestic product in the fiscal year starting July 1.

Another negative effect of raising interest rates is that it might discourage investment as the cost of borrowing from the banks will increase. But according to Al-Sherif, hiking interest rates should not impact the cost of investment projects. “The hike in interest rates will be small compared to other investment costs, such as wages, purchasing raw materials and infrastructure,” he told Al-Ahram Weekly.

The stock market reacted negatively to the hike, with the main index EGX30 plunging on Sunday and Monday. On Monday, EGX30 hit its lowest level in three months, dropping 1.83 per cent. The entire stock market has been depressed by Thursday’s interest rate hike, which surprised most investors.

A Capital Economics note also said that the main factor behind the decision was the recent surge in inflation and that it was also intended to provide some support for the beleaguered pound.

However, it said that in light of the persistent strains on the balance of payments, dwindling tourist receipts, and lower remittances and foreign capital inflows, pressures on the pound would likely continue to mount.

 The pound has weakened sharply on the black market in recent months, and it slid against the dollar last week to sell at LE10.95 to the dollar on the black market.

Before the MPC’s decision last week, a note by Pharos Research forecast that the CBE would leave rates unchanged, saying that the cost of a hike outweighed the potential benefits.

“Further rate hikes would not defend the local currency unless undertaken aggressively at two to three per cent, which would not help an already high budget deficit,” the note read.

Should inflation drag on, this might not be the last time the CBE decides to hike interest rates this year, said Al-Sherif.

Capital Economics said that inflation concerns and strains on the balance of payments were likely to dominate monetary policy decisions for the foreseeable future. “We have pencilled in an additional 0.5 per cent rise in the overnight deposit rate to 12.25 per cent by the end of this year,” it said.

Meanwhile, it warned that policymakers might feel the need to tread with caution given the weakness of the economy and said that more monetary tightening could be on the cards.

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