(Bloomberg) -- Investors are bidding up Egypt’s currency even with the wait for the central bank to resume interest-rate cuts unlikely to end for months.
Plans to lift fuel subsidies this year are certain to push up inflation, which already gained in January after ending last year within the central bank’s target range. Bloomberg Economics estimates that the complete removal of fuel subsidies would increase inflation by as much as 2 percentage points, depending on international oil prices.
But traders in the pound are betting rate cuts are only a matter of time. The Monetary Policy Committee, which last reduced borrowing costs in March as inflation eased from record highs, will hold again at its meeting on Thursday, according to five of seven economists surveyed by Bloomberg.
As easing creeps closer, the pound traded at its strongest against the dollar since March 2017. The appreciation was likely linked to investors wanting to “lock in higher interest rate yields ahead of what could be a rate cut on the horizon and increased foreign-currency inflows amid a plateaued demand” for hard currency needed for imports, said Reham El Desoki, an independent economist based in Cairo.
The currency is in the spotlight after Egypt last year ended a repatriation mechanism that ensured foreign investors could get their dollar earnings out of the country. Though it reflects growing investor confidence in Egypt, the shift toward the open market is also likely to expose the pound to more volatility.
While the central bank said it stands ready to fend off speculators and ensure debt holders don’t lose out from increased fluctuations in the currency, the Finance Ministry just cut its forecast for the pound’s value against the dollar in its mid-year report.
The pound added 0.3 percent to 17.5419 versus the dollar as of 1:11 p.m. in Cairo, bringing its gains to almost 2 percent for the year.
“The attractive yields will continue to attract more foreigners,” said Alia Mamdouh, director of macro and strategy at investment bank Beltone Financial. The “waves of outflows” that Egypt experienced last year are unlikely, she said.
For now, risks to price growth will probably take precedence for the central bank. The annual inflation rate in urban areas inched up to an annual 12.7 percent in January, stoked mainly by increasing food costs. The government is expected to lift the remaining subsidies on fuel around the end of the current fiscal year in June and then move ahead with indexing fuel prices against international benchmark Brent.
Lifting fuel subsidies is an important plank of Egypt’s economic overhaul, which saw the central bank devalue the pound and lift most capital controls in November 2016. While the move helped clinch a $12 billion loan from the International Monetary Fund, currency weakness pushed inflation to record highs above 30 percent. Policy makers then waited until last year to begin easing, but stopped after two rate cuts as an emerging markets rout prompted international investors to dump Egyptian debt.
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“Our core view remains for the central bank to continue to err on the side of caution in the months ahead, keeping rates steady until mid-2019,” Fitch Solutions said in a report. Still, the potential for volatility in financial markets poses a risk of capital flight and swings in the exchange rate, it said.
--With assistance from Rinat Gaynullin.
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