Kuwait cut its benchmark interest rate for the first time in 18 months on Wednesday as Gulf Arab central banks moved to prevent tumbling US borrowing costs from putting pressure on currencies linked to the dollar.
Saudi Arabia, Bahrain and the UAE also lowered rates on Wednesday to match Tuesday's cut in US rates and Qatar was expected to follow suit, ignoring surging inflation across the region, analysts said.
Kuwait's 50 basis point cut came as a surprise. Unlike its neighbours which maintain a fixed dollar pegs, the country tracks a currency basket dominated by the dollar.
The basket gives Kuwait more flexibility on interest rates and the central bank has left the benchmark discount rate steady since July 2006, fearing lower borrowing costs would stoke inflation which hit a record high of 6.2 per cent in September.
The central bank had lowered the repo rate by 100 basis points since September 12 to ensure investors betting on an appreciation of the dinar would not profit from better returns than they would get on US bank deposits.
On Wednesday it cut the benchmark to 5.75 per cent from 6.25 per cent and the repo, which guides interbank lending, by 50 basis points to 4 per cent.
"The discount rate is the central bank's signalling mechanism. Lending rates should follow," said Giyas Gokkent, head of research at National Bank of Abu Dhabi.
"This will encourage credit growth. Banks had been lowering their deposit rates but not their lending rates," he said.
Central Bank Governor Sheikh Salem Abdul-Aziz al-Sabah acknowledged it was a difficult decision, but said the gap between the dinar yields and interest rates on deposits in other currencies including the dollar has grown too wide.
"The aim is to reduce any negative effects that could result from the unjustifiably high margins Kuwaiti dinar deposits offer versus the main currencies," Sheikh Salem said in a statement carried by the official news agency KUNA.
Other Gulf central banks have avoided reducing lending rates at a time when record revenues from oil and gas exports are flooding banks with cash.
The Saudi central bank cut its reverse repo, which guides bank deposit rates, to 3.5 per cent from 4 per cent. It left the main lending rate, the benchmark repurchase rate, at 5.5 per cent.
The central bank of the world's largest oil exporter also raised the reserve requirement for banks to 10 per cent of deposits from 9 per cent, forcing lenders to keep more money in their vaults so that lower interest rates would not fuel inflation. Saudi inflation hit a 16-year high of 6.5 per cent in December.
"With real rates sinking deeper into negative territory and the Middle East still recording strong domestic-led growth, increasingly lower rates run the risk of pushing inflation higher," Deutsche Bank said in a note.
The UAE reduced its repurchase rate by 75 basis points to 3.5 per cent on Wednesday. Inflation in the UAE hit a 19-year high of 9.3 per cent in 2006, the latest available figure.
Bahrain cut its benchmark one-week deposit rate by 50 basis points and left its lending rates on hold.
The US Federal Reserve slashed its benchmark rate by three-quarters of a percentage point on Tuesday in an emergency move to help a US economy reeling from a mortgage crisis. (Reuters)
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