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Egypt - Monetary framework monitor | CBE to continue its balanced monetary framework

CBE tightens liquidity to preserve FCY coverage; Expect CBE to maintain rates in upcoming MPC meeting. Starting April, the CBE has been absorbing liquidity (EGP 67bn on a net basis) through its main OMO tool, the CLD, despite inflation standing at 4.5%, marginally below target (5-9%). This should provide flexibility for monetary expansion, remaining within the CBE’s target inflation. The absorption trend was preceded by two consecutive months of liquidity injection in February and March. This comes in line with our projected balanced M2 growth, to maintain a sustainable FCY cash cover ratio and currency stability. The tighter liquidity aims to maintain the FCY cash cover ratio c1.2, despite possible outflows, on global market volatility. We expect the CBE’s conservative liquidity policy to be complimented by maintaining rates in the upcoming MPC meeting, on 28 April.

EGP carry trade remains favourable relative to EM. Egypt continues to outperform EM peers, offering a real yield of 8.81% vs. 0.04% and 4.03% for Turkey and Ukraine, respectively. In contrast to Egypt, Turkey’s inflation rate continued accelerating in March, reaching 16.19%. Nonetheless, the CBRT maintained interest rates at 19%. Egypt’s CDS are at 325bps vs. 411bps and 476bps for Turkey and Ukraine, respectively, allowing Egypt to maintain a favourable carry trade. Alleviated global dynamics, including the US ten-year yield sliding 15bps to 1.56%, below 1.6% for the first time since 25 March, allows for a potential EM currency revival in 3Q21.

Global dynamics contribute to elevated local yields. Average T-bill yields currently stand at 13.31%, as of 21 April, up 1% y-o-y (12.31% in Apr-20), +42bps y-t-d. Meanwhile, average five-year and ten-year T-bond yields are currently at 14.69%, +1.33% y-o-y, and +47bps y-t-d. This compares to 400bps of total cuts throughout 2020. We attribute the divergence between yields and policy rates to: i) the willingness to maintain attractive yields for foreign investors, being a major source of BoP’s foreign currency sources over the past year, and ii) Egypt’s market, coupled with global dynamics and impacted by rising US ten-year bonds. That said, we see new sources of FCY (namely tourism and inflows on JPMorgan EM bond index inclusion) supporting the alignment of the yields.

Inflation unlikely to exceed 6.5% until year-end. Although we expect April y-o-y inflation to decelerate on a base year effect, we see y-o-y food prices increasing in the coming months, on a global rise in raw material prices, alongside restocking food reserves. Notwithstanding the Octane 92, 95, and 80 hike by 25 piasters (average 3.4% drop, reversing Mar-20 cuts), we anticipate a limited broad based inflationary impact, as diesel prices remain unchanged. We look for inflation to remain between 5-6% until year-end.