Tightening cycle has likely come to an end
Having raised rates by 400bps in nearly a month, we think CBE’s tightening cycle has likely come to an end. Fiscal measures for FY17/18 are now mostly behind us, and higher rates are likely to stabilise private sector credit, leaving less reasons for further tightening. Moreover, favourable base effects are likely to send inflation around 10pp lower by December and start 2018 in the teens, according to our estimates, bringing real interest rates closer to positive territory towards mid-2018. CBE’s last statement indeed pointed to “measured easing”, as soon as underlying inflation starts to moderate. Inflation readings though are likely to remain elevated for the next couple of months as recent fuel subsidy cuts feed into general price levels (we reckon inflation will peak at 33-35%) and falling, thereafter, leaving good prospects for a cut starting 4Q17, in our view. CBE has four remaining meetings this year (17 August, 28 September, 16 November and 28 December).
 
Increased pressures to activate FX transmission
One of the typical transmission channels of tighter monetary policy is the currency channel, though this remains largely blocked in this case, given the existence of the repatriation mechanism. The latter continues to prevent the EGP from reaping the benefits of now USD10bn in net inflows into the local FX market since November. We reiterate our view that it is now timely for CBE to activate this transmission to reap the full benefits of the latest round of tightening. This is more so, given the rapid increase in foreign holdings of Treasury-bills, which have now nearly reached USD10bn, coming in at a significant cost to foreign reserves. Activation would take the form of an increase in the cost of repatriation mechanism for future trades – more suitable for a gradual transition to a more free market – or cancelling the mechanism altogether. 
 
Still seeing chances for some appreciation in 2017
Changes to repatriation mechanism will likely result in EGP appreciation, in our view, as portfolio flows go directly through the interbank market. We hold our end-year trading target of EGP16-17, with risks tilted way more towards the upper end of the range. While this could initially lead to a correction in the carry trade, as some investors lock some profits, we expect Egypt’s high domestic yields and improving macro/fiscal position to keep investors keen on the trade. Eventually, more investors will likely migrate towards the long end of the curve, as short-term yields are set for a normalisation path, ensuring sustained flows, which we believe will, for a while, remain by far the largest source of surplus of the FX market. Please see our latest notes on equity market implications and winners and losers of an EGP appreciation.

Mohamed Abu Basha