The Central Bank raised interest rates on Thursday, hoping to curb soaring inflation and slow a sliding pound currency, but the first increase in over a year is likely to hurt a very weak economy.
The bank's Monetary Policy Committee (MPC) announced 50 basis point increases in both its main rates, taking the overnight deposit rate to 9.75 percent and the overnight lending rate to 10.75 percent.
Before the meeting, economists had been split on whether the bank would raise rates or hold them to avoid further hurting an economy badly damaged by two years of political turmoil and frequent violent protests since the overthrow of former President Hosni Mubarak.
In the end, the Central Bank opted to tackle the sharp rise in inflation, which is eating into Egyptians' living standards, and to support the pound.
"Despite the downside risks to the GDP outlook, the MPC judges that disanchored inflation expectations are more detrimental to the economy over the medium term. Hence, a rate hike is warranted," it said in a statement.
In a further blow to economic confidence, Moody's Investors Service downgraded Egypt's sovereign credit rating on Thursday to Caa1 from B3, citing unsettled political conditions, and said risks of a default had increased.
The pound has lost 9 percent of its value against the dollar since late last year, pushing up the cost of imported goods. Inflation in towns and cities jumped to 8.2 percent in the year to February from 6.3 percent in January.
The Central Bank blamed the jump in inflation on diesel fuel supply problems and "broad-based increases in food and non-food prices on the back of the recent movements in the exchange rate."
It also acknowledged the effect of Egypt's turbulent politics. "The current political transformation may continue to have ramifications on both consumption as well as investment decisions, adversely weighing on key sectors within the economy," it said.
President Mohamed Morsy called parliamentary elections last month which had been due to start on 22 April, only for a court to cancel his decree. Much of the liberal and leftist opposition had already said it would boycott the vote.
Thursday's rate rise is likely to hit economic growth, which the government projects will be 3 percent in the year to June — far below the 7 percent that economists believe is required to create enough jobs for a rapidly expanding population.
With currency reserves now at a critically low US$13.5 billion — little more than a third of the level before Mubarak's fall — the Central Bank is tightly rationing dollar supplies through currency auctions.
A US$4.8 billion loan from the IMF has yet to materialise and many investors and businesses are finding it nearly impossible to get hold of dollars through the banking system. This is forcing them to accept highly unfavourable black market rates, often wiping out their profits.
The Central Bank also said on its website that it had raised its main repo and deposit auction rates by 50 basis points to 10.25 percent and the discount rate by 75 basis points, also to 10.25 percent.
It last changed monetary policy in November 2011 when it raised the overnight deposit rate by 100 basis points and the overnight lending rate by 50 basis points.
