Gulf states brace for fresh rate cut

 
Gulf states are again expected to shun strong inflationary pressures and cut interest rates for the seventh time in less than a year to match an imminent rate reduction in the United States, analysts said on Thursday.

The move to echo a widely expected decision by the US Fed late this month or in early May will likely spur money supply growth and aggravate inflation, which instead requires regional oil producers to raise interest rates to curb strong domestic demand, they said.

The UAE, Saudi Arabia and Qatar, which have closely followed the US rate policy over the past few months, are expected to stick to that line and cut interest rates again after they announced last week that there is no intention to unpeg their currencies from the dollar.

“Of course, if the US Fed cuts interest rates again, the Gulf countries will follow suit… I do not think they have any choice as long as their currencies are tied to the US dollar,” said Mohammed Al Asumi, a well-known Gulf economist.

 

“This is the negative side of the peg. While they need to raise rates to tackle inflation, they are only complicating these efforts… further rate
cuts will only increase inflationary pressures.”

The three countries have cut their repo or reverse repo rates six times by a total of 275 basis points since September to match cuts by the US Fed seeking to give a shot in the arm to the slackening economy. Experts described this situation as an anomaly since Gulf states need to keep or even raise their interest rates on the grounds their economies are passing through a boom period rather than a recession.

But they said Gulf central bank governors cannot move in an opposite direction as long as their currencies are pegged to the dollar. Speaking at an anti-money laundering conference in Abu Dhabi last week, UAE Central Bank Governor Sultan bin Nasser Al Suwaidi indicated there might be more rate cuts when he said there were no plans for the time being to detach GCC currencies from the greenback.

In its latest weekly bulletin, Saudi Arabia’s largest bank, the National Commercial Bank, said it expected the US Fed to cut interest rates by another 50 basis points at the end of this month. Payroll employment in the US fell 80,000 in March, below widely expected 50,000 decline. The unemployment rate rose to 5.1 per cent from 4.8 per cent, confirming that the labour market remained weak, and keeping Fed on track for another rate cut this month,” the bank said.

“In his testimony to the joint economic committee, Chairman Ben Bernanke’s remarks were consistent with the view that the Fed will cut funds rate again later this month, although he gave no guidance about the size of the cut. While this is likely to depend on market developments, we expect the cut to be 50 basis points.”

Inflation rates have swelled to record levels in most GCC states, including Kuwait despite being the only Gulf Co-operation Council member to quit the dollar and peg its dinar to a basket of currencies.

Gulf officials have sought to minimise the impact of that peg, saying the ailing dollar is playing only a small part in inflation. They cited other main factors, including strong domestic demand, and a surge in rents and food prices. According to another Saudi financial institution, regional states could continue to match the Fed rate cuts down to one per cent.

“With the Fed funds rate at 2.25 per cent, there is still scope for further interest cuts [the bottom of the last US rate cycle was just one per cent],” said the Riyadh-based Jadwa financial and investment services company.

In another report last week, a UN organisation said Gulf states faced a fiscal plight in their struggle to curb inflation.

“Currently, with the exception of Kuwait, all the GCC countries peg their national currencies to the dollar. As a result, GCC monetary authorities face a serious policy challenge, namely: they can follow the latest moves by the Fed and reduce benchmark interest rates at a time when strong economic growth and increasing inflation rates would instead require a tightening of monetary policy,” the Economic and Social Commission for Western Asia (ESCWA) said.

“Or they can allow a widening spread between domestic and US interest rates, thereby stimulating capital inflows and possibly further increasing the pressure on national currencies… such a dilemma has prompted calls by analysts to move to more flexible exchange rate regimes such as replacing the dollar peg.”