• Seasonality, fiscal reform and devaluation drive inflation jump Headline consumer price inflation jumped to a year high of 12.3% Y-o-Y in May from 10.3% in April as inflationary pressures intensify. Food inflation accelerated to 14.3% Y-o-Y and non-food to 10.4% Y-o-Y while core inflation accelerated to a seven-year high of 12.2%. Headline inflation spike was mostly driven by: i) Ministry of Health’s directive to increase the price of medicine; ii) seasonality associated with Ramadan; and iii) continued feed through of the EGP devaluation. The outturn came higher than our forecast of 9.8% due to the price adjustment of medicines, as well as higher food inflation than anticipated.
• Adjust inflation forecasts… We adjust our inflation forecasts to take into account the repricing of medicines. We now forecast average inflation of 10.2% for FY15/16 (vs. an earlier 9.8%) and 12.5%% for FY16/17 (vs. an earlier 11.5%). Our forecasts include a 1.5pp impact from VAT in FY16/17 which might change depending on the timing of implementation, the tax rate and list of exemptions. The law is being reviewed by the State Council, which needs to approve it before it is referred back to Parliament.
• …and adjust policy rate call for a 25 bps hike on 16 June While the CBE has raised policy rates by 200bps since December, we see May’s sharp inflation acceleration – especially that of core inflation – warrants a move by the central bank. We therefore expect a 25bps rate hike on 16 June meeting, frontloading part of the 50-100bps hike we expect in 2H16 associated with the implementation of VAT. Thursday’s decision remains a controversial one with higher interest rates adding to pressure on the fiscal budget – the largest borrower in the economy – and partially having a limited impact on a supply-shock driven inflation.
• Outturn highlights pressure on disposable incomes The May inflation numbers demonstrate our view that consumer disposable income is coming under intense pressure since the beginning of year as consumers face a number of inflationary headwinds. A weaker EGP, fiscal adjustment, public wage restraints and falling incomes from remittances and tourism are all factors leading us to expect decelerating private consumption growth in FY15/16 and FY16/17. This is even more the case when considering upcoming fiscal measures, in terms of the third annual electricity price hike in July and VAT implementation in 2H16.

Mohamed Abu Basha