Diminishing base effect drives inflation upwards

 
Egypt’s annual urban headline inflation accelerated in Nov for the first time in six months, rising to 3.6%, from 3.1% in Oct. This confirms our view that inflation had reached a trough in Oct and is set to print an uptrend in the last two months of the year as it normalises from a highly depressed base in 2018. The reading came slightly lower than our expected 4.2%, largely due to a stronger-than-expected decrease in food prices. Monthly inflation trends were quite subdued, with headline inflation dropping 0.3%, driven by a 1.6% contraction in food prices – on the back of sharp drops in the prices of vegetables, red meat and poultry – while non-food inflation inched up 0.2%. The monthly drop in inflation is reflective of seasonal trends, as headline inflation typically contract in Nov and Dec, on seasonal drops in food prices. Nevertheless, overall weakness in inflation, particularly core inflation, which has been in low single-digits for nearly two years now, does reflect softness in private consumption growth, with anecdotal evidence suggesting that companies have been refraining lately from price increases, amidst lower volume growth as consumers still adapt to the past three years’ economic adjustment.
 
Marginal reduction in inflation forecasts for FY20

 
We tweak our inflation numbers, as inflation has slightly undershot our estimates for the past three months and also taking into consideration the new consumer basket that has reduced the weight of food in the overall basket. We now expect inflation to end the year at 6-7%, instead of an earlier 7-8% and forecast average inflation of 5.9% in FY19/20, from an earlier 6.7%. We note that these inflation numbers are below Egypt’s historical normalised inflation, of 9-10%, pointing to normalisation in inflation trends, following quite-elevated inflation readings in the past three years, and also clearly indicative of a weak consume backdrop. Private consumption growth has been notably subdued, as per the latest GDP numbers, growing only 0.7% in 9M18/19 in real terms (i.e., well-below the population growth rate of 2.5%). Upside risks to the inflation outlook remain largely weak, with oil prices mostly stable around the USD60/b mark, and foreign interest in Egypt’s attractive yields are likely to keep the USD-EGP stable. 
 
Rates likely on hold in Dec; CBE to resume rate cuts in 1Q20

 We maintain our forecast of the Central Bank of Egypt’s (CBE) holding policy rates steady at its last meeting of the year (on 26 Dec) in order to better assess more sustainable inflation levels, having cut rates by 350bps in the past three meetings and 650bps in the past two years. We think inflation readings for Dec and Jan will provide the CBE with enough indication of the normalised inflation levels, allowing for better assessment of inflation outlook. Considering the above-mentioned revision to inflation numbers, we expect 150-200bps of rate cuts in 2020, starting with 50-100bps in 1Q20; we have argued before that our base case is for a 100bps of rate cuts and a bull case of 200bps. With our downward revision of inflation forecasts, we think the CBE will now have enough room to cut rates by a larger magnitude, whilst still offering fixed-income investors a lucrative real yield. Lower rates should be complemented with an overall easing in monetary policy, reflected in the reversal of system liquidity drainage, though we think CBE will be cautious with the latter, in order not to ignite inflationary pressures or put upward pressure on the EGP, in our view.

Mohamed Abu Basha

Mostafa El Bakly