DUBAI?Egyptian stocks rallied again Monday after its central bank floated the tightly managed local currency late last week, despite fears that the move could substantially raise the cost of living for ordinary Egyptians.

Egypt's benchmark stock index closed 5.4% higher Monday, after adding more than 9% over the past two sessions on expectations that the currency float will likely help the cash-strapped country secure a much needed $12 billion International Monetary Fund loan. The Egyptian pound traded at 16.50 per U.S. dollar, according to several local banks, compared with a rate of about 8.88 per dollar that the central bank had maintained since March.

But a sharply weaker currency is expected to cause another problem: it will spike the cost of living for Egyptians, who are already struggling to cope with high inflation in an economy battered by years of political unrest.

London-based Capital Economics expects inflation to climb to more than 20% in the coming months, from about 14% in September, as the Egyptian pound's fall against the U.S. dollar increases the cost of imports, especially for food items that Egypt buys in large quantities.

"Food inflation could rise to more than 25% in the coming months," says Jason Tuvey, Capital's Middle East economist, adding to overall inflation.

Other imported goods will also become more expensive, and alongside an increase in fuel prices announced late last week add to the inflationary pressure in the Middle East's most populous country.

"Grocery prices are rising too quickly," said Ahmed Mohamed, who lives in Cairo with his wife and daughter, noting "We were already struggling."

Inflation and unemployment were among the major factors that led to the popular overthrow of President Hosni Mubarak in 2011.

Still, the Egyptian government has little choice but to let the currency weaken and cut fuel subsidies?those moves will help the country meet IMF requirements to get final approval for the loan package, cash that will help revive the economy and create jobs.

A flexible exchange-rate regime will also support the Egyptian government's efforts to attract foreign direct investment and improve trade competitiveness, which, in turn, will fuel economic expansion, according to Moody's Investors Service.

Tourism and foreign investments?vital sources of hard currency?have yet to recover after the uprising in 2011. Egypt's foreign reserves fell by more than half to about $16 billion earlier this year from pre-uprising levels. Recent aid and loans have helped boost those reserves to $19.6 billion at the end of September.

The country in recent years has rationed the dollars it had to pay for vital imports such as wheat and medicines, forcing companies to tap the black market to fulfill their foreign currency needs.

Egypt's central bank on Thursday said the decision to float the pound was intended to return foreign-currency trading to the formal banking sector and away from the black market. The gap Monday narrowed between the official exchange rate and the black market, where the pound was exchanging at about 17.3 per dollar, according to some traders.

As Egypt takes steps such as increasing interest rates and canceling some import tariffs to cope with the expected jump in inflation, the currency black market may turn out to be helpful.

A large number of import transactions were already being funded with dollars purchased at the weaker black market rate.

"As a result, the effects of a weaker pound may have started to have an effect on inflation even before the official exchange rate was devalued," Mr. Tuvey said. He expects the impact from the currency float and subsidy cuts to be temporary, with inflation possibly starting to ease in the middle of next year.

Alaa Mohamed in Dubai contributed to this article

Write to Nikhil Lohade at Nikhil.Lohade@wsj.com

(END) Dow Jones Newswires

November 07, 2016 11:45 ET (16:45 GMT)

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