Egypt's central bank surprised financial markets by raising its policy rates by 100 basis points, saying a "preemptive rate hike is warranted to anchor inflation expectations and hence limit a generalized price increase, which is detrimental to the economy over the medium-term."
The Central Bank of Egypt (CBE) has maintained its rates this year after cutting them by 100 basis points last year, but said in May that it would not hesitate to raise rates to ensure price stability over the medium term and repeated this guidance today.
Egypt's government has revised upwards prices of several regulated items including fuel, electricity and tobacco as part its 2014/15 fiscal consolidation plan.
"While the fiscal consolidation will improve the fiscal sustainability over the medium-term, a relative price increase in inevitable," CBE said, adding the initial effect of the price changes will lead to an increase in July inflation while the indirect and second round effects could be reflected in both headline and core inflation in the quarter ending September, posing a risk to the inflation outlook.
"Therefore, while the MPC acknowledged the favorable medium-term effect of the fiscal measures, it is mindful to the importance of anchoring inflation expectations," the central bank said.
Egypt's headline inflation rate was largely steady at 8.2 percent in June and May while core inflation eased to 8.76 percent from 8.86 percent in May as there has been a notable slowdown in the prices of several food items.
In addition, the central bank said a sharp rebound in international food prices is unlikely, resulting in contained upside risk from imported inflation.
Egypt's economy improved slightly in the first calendar quarter of 2014, or the third quarter of fiscal 2013/14, with Gross Domestic Product expanding by 2.50 percent compared with growth of 1.4 percent and 1.04 percent in the previous two quarters.
The pickup in growth was due to an improvement in manufacturing and construction despite a contraction in tourism and petroleum sectors and continued low investment.
Downside risks to the global economic recovery and softer growth in emerging markets could also pose risks to Egypt's economy going forward, the bank said.
Economists had expected CBE to maintain its rates today to help stimulate the economy after more than three years of stagnation after Hosni Mubarak was ousted in a popular uprising in 2011.
In addition to the overnight deposit rate, the central bank also raised the overnight lending rate, the rate of the CBE's main operation and the discount by 100 basis points to 10.25, 9.75 percent and 9.75 percent, respectively.