Business | Economy
Rate cut to fuel further inflation
The UAE follows the US Federal Reserve's actions in line with its dollar peg, though local lenders do not generally use the repo measure to set their deposit and lending rates.
- By Ahmed A. Elewa, Senior Reporter
- Published: 00:38 March 20, 2008
Abu Dhabi: The reduction of the key repo interest rate in the UAE by 75 basis points from three per cent to 2.25 per cent will boost economic activity in the short term, but will result in higher inflation and other serious consequences in the longer term, econ-omists said on Wednesday.
The UAE follows the US Federal Reserve's actions in line with its dollar peg, though local lenders do not generally use the repo measure to set their deposit and lending rates.
"We have reduced the repurchase rate for the certificates of deposits from three to 2.25 per cent to match the Federal funds rate," Mohammad Abdullah, assistant executive director of the treasury department at the central bank said.
Saudi Arabia and Bahrain, which also peg their currencies to the dollar, lowered their policy deposit rates by 75 basis points yesterday, matching the cut in the US. Qatar was yet to decide on its response yesterday, and Kuwait kept rates unchanged.
"The direct impact of reducing the interest rate is increasing liquidity, and that does not come as a reason of a lower cost of borrowing, as the lending rates do not change, only the repo rate is affected. Rather the negative real interest rate makes it more costly to keep money in the banks," said Rami Sidani, senior associate partner at Shuaa Capital.
Other actions available to the Central Bank include raising reserve requirements at the commercial banks, as Saudi Arabia has done, or to modify the peg to track a basket of currencies as Kuwait has done.
"In the shorter term, a lower interest rate entails more liquidity, and hence more consumer and investor spending, yet this will definitely result in higher prices across the board," commented Dr. Giyas Gokkent, head of research at the National Bank of Abu Dhabi (NBAD).
"In the longer term of one to two years, when interest rates start climbing again, this can have a serious effect on the real estate sector, as appreciating property prices can suffer from a sharp correction by then," he explained.
In 2007 inflation stood at 10.9 per cent and it is expected to rise in 2008 given the lower interest rates, according to NBAD.
"If the government is setting a target inflation rate of five per cent, and has already taken steps to this end, it is hard to see it fulfilling this goal given the low cost of borrowing. In the longer term of one to two years, when interest rates start climbing again, this can have a serious effect on the real estate sector," Gokkent said.
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