• Headline deceleration overshadows building inflationary pressures Annual headline inflation decelerated to six-month low of 9.0% Y-o-Y in March from 9.1% in February, driven mostly by favourable base effects. Annual food inflation slowed for the third month to 12.1% (from 12.5% in February), while non-food inflation showed a minimal uptick to 6.3%. Such favourable annual trends, however, overshadow the build-up of inflationary pressures, which can be traced in monthly inflation numbers (Fig. 2), as the EGP depreciated significantly in the parallel market before the CBE pushed a c12% devaluation of the EGP in mid-March. Food prices went up 2.0% M-o-M in March, the most in six months, and following a 1.7% jump in February. The increase came across a number of food items, including key staples (Fig. 3).
• Devaluation, VAT to keep inflation risks to the upside The draft value-added tax (VAT) law submitted to Parliament calls for a 14% flat tax rate, which we estimated would potentially add 1.5 percentage points to headline inflation when implemented, likely towards mid-2016. We note that the law is yet to be discussed in Parliament; hence, the tax rate may be subject to amendments. In addition, the recent devaluation of the EGP is likely to increase inflation expectations and keep upward pressures on prices in the short term. March PMI numbers showed private sector companies reporting a big jump in input costs, with some already starting to pass these on to the end consumer. Anecdotal evidence suggests more companies are likely to follow suit. We expect inflation to go back to double-digits by mid-year and average 11% Y-o-Y in FY2016/17 compared to 9.4% in 2015/16.
• Still see room for further rate hike in 2016 The implementation of the VAT, probably accompanied by a few other fiscal measures including fuel subsidy cuts and higher tobacco prices, warrants a further rate hike in the range of 50-100 bps, in our view. This would come over-and-above a total policy rate tightening of 200 basis points since December, and the CBE’s efforts to tighten liquidity to cool down inflation and speculative activities against a weaker EGP. We, therefore, see the recent drop in government debt yields in the range of c20-50 bps (Fig. 6) as temporary.

Mohamed Abu Basha