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10-Jan-2019

Egypt Economics - Inflation drop close to three-year low in December as food price shock subsides

Sharp drop in vegetable prices brings inflation back to norm

Egypt’s headline urban inflation decelerated sharply in December close to a three-year low of 12%, down from 15.7% in November, as the food price shock subsided. The latter drove inflation higher between July and October, but started to fade in November and did so with an accelerated pace in December: vegetable prices dropped a whopping 21% M-o-M and fruits 1.3% M-o-M. These price falls drove a sharp decline in food inflation of 6.7% M-o-M, leading to headline inflation falling by 3.4% M-o-M in December. Meanwhile, non-food inflation was up by only 0.2% M-o-M, providing further evidence that inflation trends have indeed been on a normalisation trend over the past few months after nearly a couple of years of elevated readings due to the macroeconomic adjustment measures. The numbers confirm our view that the sudden spike in inflation over the past few months was largely driven by a temporary, seasonal shock in food prices that was bound to fade away, judging by historical trends and the short-term harvest nature of fruits and vegetables.
 
Oil prices key factor for 2019’s inflation outlook

With the food price shock officially subsiding, the fuel price liberalisation is set to be the key determining factor of inflation dynamics in 2019. The government announced earlier this week the indexation mechanism, starting with 95-octane gasoline, with the first price adjustment set for April at a ceiling/floor of 10%. The plan then is for all fuel products to be indexed in July, with the first price change implemented in September, according to the Minister of Petroleum. As such, oil price developments will shape inflation in 2H19: at USD60/b oil, fuel prices would need to rise by 15-20% to reach cost recovery; meanwhile, at USD75/b, the average increase would step up to 35-40%.
 
Should we get excited about a rate cut?

While we think today’s inflation reading, with the potential of some further deceleration in January, theoretically opens the room for some degree of monetary easing in 1H19, our initial take is that the Central Bank of Egypt (CBE) will likely opt to remain on the conservative side and keep policy rates on hold. The sharp deceleration in inflation this month indeed provides Egypt with a large +5pp margin of positive real rates, but we note that this was the same condition back in 2Q18 when the CBE stopped the easing cycle for the same two factors, namely oil price and global markets’ volatility, which continue to exist today. Oil is clearly trading at a far lower price than its peak in 2018, but it has already recovered to above USD60/b from trading below USD50/b just a few weeks back, with more volatility expected over the course of 2019. Such volatility does not allow for much visibility for kicking off an easing cycle, in our view. In addition, emerging market volatility has clearly eased, but the market is yet to see any sign of revival of capital inflows, which remain important to fund the current account and fiscal deficits. 

Mohamed Abu Basha