UAE equities will soar to a six-month bull run on the wings of the US Federal Reserve’s latest interest rate cut, but the long-term consequences could be less than rosy for the country’s stock markets, economists and brokers predict.
The UAE Central Bank has slashed its benchmark repo rate by 50 basis points to three per cent, following a similar move by the Fed on Wednesday. This means local interest rates have been reduced by 1.25 per cent in the past 10 days, with UAE monetary policy effectively set in Washington because of the dirham’s dollar peg. “This will be positive for equity markets in the short term,” said Marios Maratheftis, Standard Chartered regional head of research. “There’s already huge liquidity and cutting the interest rates will lead to asset-price inflation. The problem is that if assets – from equities to real estate – are rising because of loose monetary conditions, then this is not sustainable because it’s not based on fundamentals.”
Economists warn the US experienced a similar phenomenon when cheap borrowing fuelled a price boom, only to see the value of assets plunge when the market conditions changed, as witnessed by the ongoing sub-prime crisis.
“In the short to medium term, this cut strengthens the local equity and real estate markets,” said Mohamed Alami, Naeem Shares and Bonds relationship manager.
“Negative real interest rates mean investors are trying to beat inflation and so cannot just leave their money in the bank. People are being pushed to borrow aggressively to try and beat the market and are basically left with two easily accessible options – property or stocks.”
Maratheftis predicts US rates will eventually fall to one per cent, while Alami says the latest cut will provide the UAE stock markets with the momentum to launch a six-month bull run. “This should lead to a structural shift in prices, with stocks likely to become overvalued,” said Alami.
“If this reaches extreme levels and stock trade at 50 times their price-to-earnings ratios then I will be selling my stakes because a bubble that big can only burst,” he added.
Maratheftis recommends dropping the dollar peg altogether in favour of a basket of currencies, although such a move remains a remote possibility because of opposition from other GCC members. If the peg is to remain, Maratheftis says the dirham should be revalued by 20 per cent, although 10 per cent is more realistic.
“The chances of a revaluation this year is more than 50 per cent,” he said. “The danger is that if inflation continues to rise unchecked we could end up with a devaluation, not a revaluation of the dirham. The key difference is that while you can revalue at your choosing, you cannot delay devaluing, so it makes sense to revalue sooner rather than later.”
If the UAE was able to raise interest rates it would lead to a slower, but sustainable rise in asset prices, economists believe.
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