Egypt's currency seems unlikely to rebound substantially from 3-1/2 year lows any time soon because investor appetite for Egyptian assets may be blunted by uncertainty before a 2011 election -- and the central bank may prefer a weaker pound.

The Egyptian pound has marked a series of lows against the dollar in the past two weeks, partly because of a firmer dollar globally as weakness in the US economy prompts safe-haven flows into US Treasuries. Last Thursday, the pound fell as low as 5.7056 after touching 5.7057 on Tuesday, its lowest level since January 2007.

Some analysts argue the pound is unfairly undervalued since Egypt's economic growth is ticking higher and fund inflows from abroad have been recovering, while the central bank may start leaning towards raising interest rates late this year as the risk of inflation grows.

Annual figures released by the central bank on Monday implied a balance of payments surplus for the April-June quarter of $249.7 million, a turnaround from a deficit of $1.04 billion a year earlier. Net portfolio investment, mainly purchases of equities and Treasury bills and bonds, recorded a $768.1 million surplus versus a $154.9 million deficit.

Economists say faster growth has boosted prospects for state revenues, helping to push Egyptian Treasury yields lower. The public sector deficit was 8.3 per cent of gross domestic product last year and the market expects it to remain flat or slightly lower in the current fiscal year to June 30, even as higher wheat prices inflate the government's import subsidy bill.

Annual urban consumer inflation in Egypt held steady at 10.7 per cent in the 12 months to July, but month-on-month inflation was 2.3 per cent, the highest since August 2008 and up from a 0.7 per cent rise in June. Much of the rise was due to the approach of the Ramadan holy month and the imposition of a sales tax on tobacco, but given pressure on food price inflation, some analysts think an interest rate hike is possible around the end of this year.

"There's no particular reason for the pound to be weakening and generally investors are hoping that all these forces, as well as the recent pick-up in inflation, might cause the pound to appreciate a little for the rest of the year," said EFG Hermes economist Mohamed Abu Basha.

Central Bank

Other factors are less positive for the pound, however. Egypt's political future is less certain after three decades of stability under 82-year-old President Hosni Mubarak, who has not said if he will stand for a new six-year term in the presidential election due sometime next year.

Many Egyptians think his son Gamal, 46, will take his place and continue a policy of economic liberalisation combined with strong state control over society and politics.

Father and son have both denied any plan for a family succession, however, and the eventual transfer of power is seen by many investors as a significant long-term political risk.

For now, there is little sign of any major flight of capital from Egypt because of this risk. Such a flight would probably be reflected in rising treasury yields, but the average yield on Egyptian 91-day treasury bills was 9.637 per cent at an auction on Sunday, down from 10.27 per cent in mid-June.

But central bank policy may also weigh on the pound; many analysts believe the central bank wants to stimulate exports and is focused on amassing foreign reserves to ensure it has the financial firepower to defend the currency if necessary ahead of the presidential poll next year.

Egypt's net foreign reserves stood at $35.3 billion in July, up from $32.9 billion a year earlier. In addition to official reserves, the bank had amassed more than $4 billion in other foreign exchange by June, according to BNP Paribas figures.

"There is either a deliberate attempt to weaken the pound, or to build reserves to cushion...in the event of an outflow of money in the run-up to the 2011 presidential (election)," said Shahin Vallee, BNP's head of emerging market foreign exchange strategy.

The pound's drop since late August below the psychologically important level of 5.70 against the dollar suggests to many traders that the central bank lacks appetite for a stronger currency.

"They might be in for some competitive devaluation," said Vallee. "People were thinking 5.70 was the threshold for them, but that doesn't seem to be the case."

Traders say the central bank often intervenes indirectly to keep the pound at a preferred level via Suez Canal Bank, which receives dollar receipts from the Suez Canal Authority, and Arab African International Bank. The central bank does not comment on such interventions.

However, Vallee and others said they would be surprised if the pound fell as low as 5.82, last touched in early 2005 when the currency was recovering from a sharp drop that followed the introduction of a free float.

Analysts said the bank might expect the pound to get support from Egypt's improving economic outlook and the possibility of higher interest rates before the end of 2010, so it may simply be keeping the currency down for now in order to prevent a strong uptrend from developing -- not in order to create a downtrend.

Technically, the Egyptian pound faces strong resistance at 5.66, its August peak. Any break of that barrier would trigger a double bottom formed by the July and September lows, and targeting the 5.62 area. – Reuters