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10-Jun-2018

Egypt Economics - Two-year low inflation in May provides relative comfort for monetary policy ahead of subsidy cuts

Inflation decelerates to two-year low of 11.4% in May, in line

Egypt’s headline consumer price inflation decelerated to 11.4% in May from 13.1% in April, thanks to a continued slowdown in food inflation, which slowed to single-digits for the first time in nearly three years. The outturn came in line with our projected 11.5%, providing some comfort after a slightly elevated reading in April and ahead of upcoming subsidy cuts. Monthly inflation trends were positive (0.2% M-o-M for headline), and even surprising when it comes to food inflation, which declined 0.3% M-o-M – following three months of cumulative increases of 5.0% – despite typical seasonal price pressures associated with Ramadan. The drop came as more volatile items of fruits and vegetables saw large price declines (see Fig. 3), which by far outweighed price increases in key staples. Meanwhile, non-food inflation remained elevated at 0.6% M-o-M (unchanged from April’s levels) with a number of components of the basket seeing relatively small price increases. 
 
Inflation to accelerate with subsidy cuts but to remain within CBE’s target

We stick to our forecast of inflation continuing to decelerate in June (towards 11%) before accelerating towards the 13%-mark in 2H18 as the government pushes ahead with a new round of energy subsidy cuts. We assume an increase of 30-35% in fuel and 50% in electricity prices in July, leading to a 3.6% M-o-M increase in inflation, before normalising at sub 1% in the remainder of the year. The relatively muted Y-o-Y headline number despite the expected fuel price hikes predominantly reflects the high base of 2017, which included inflationary pressures of the devaluation, value-added tax and two rounds of subsidy cuts. 
 
Rates likely on hold, awaiting more visibility on oil prices

Today’s inflation outcome expands the margin of real positive rates by 1.8pp to 5.9%, leaving CBE with a comfortable buffer ahead of the upcoming fuel price hikes. As such, we do not see a need for CBE to react to the fuel price hike, especially with inflation likely to be within its target of 13% +/-3%. And while the subsidy cuts would still leave CBE with a comfortable margin of positive real rates of 4% by end-2018, we still expect it to maintain rates on hold at least until 4Q18 to: i) ensure the subsidy cuts do not have any surprising second-round effects; and ii) seek better visibility on global oil prices. The latter, and the fiscal response in light of so, would largely determine the direction of the monetary policy. In this context, our base case scenario is for oil prices to remain elevated (+USD70/b) until year-end, thereby prompting CBE to keep policy rates on hold. A case for a rate cut in 4Q18 would emerge if oil prices revert back towards the USD60/b.

Mohamed Abu Basha