Our main argument is that the Central Bank of Egypt (CBE), in adopting a more data-driven approach to monetary policy over the past year, has allowed rates to drift into unprecedentedly high territory, leaving it with more to do than would have been the case had a more forward-looking approach been taken. We show that, whether measured on an ex post or ex ante basis, real interest rates today are in double digits and stand at around twice their previous highs since 2007.
As the factors driving the CBE’s cautious approach recede (high inflation and post-flotation FX volatility), a normalisation of the rate environment is urgently needed, in our view. Record-high real rates are exacerbating the economic and fiscal headwinds that Egypt faces, in our view. Growth has declined to just over 4% this year, and interest payments have risen to over 75% of revenues. We estimate that the debt/GDP ratio is 7pp higher today than would have been the case had real rates been at more ‘normal’ levels.
While there is broad consensus that the benign February inflation print now paves the way for the easing cycle to begin (starting in April), the pace at which the CBE will cut is the subject of some debate. Historically, the evidence suggests that policy rates tend to converge with the prevailing inflation rate, but that adjustment tends to be relatively slow (the CBE has not cut rates by more than 650bp in any 12-month period since 2007).
Despite this, we continue to forecast 800bp in cuts in Q2 of this year alone, and a cumulative 14.25pp in cuts by the middle of next year. We think this is justified by the sheer scale of the misalignment between the current policy stance and underlying inflation dynamics, as evidenced by historically high real rates. We acknowledge the arguments in favour of a more measured decline in rates – the cautious pivot in the CBE’s reaction function and concerns around capital flows/dollarisation and the currency – and set out our reasoning as to why we believe these should not be a binding constraint on the pace of cuts.
