Gulf follows Fed rate cut quickly

Dubai: The Gulf central banks, including the UAE Central Bank, on Wednesday adjusted either the inter-bank lending rates or deposit rates in response to a quarter of a per cent interest rate cut by the US Federal Reserve.

Currency market analysts and economists believe that the quick move by Gulf central banks this time is aimed at preventing speculation in regional currencies.

Delays to interest rate cuts following the past two rate cuts by the Fed in September and October resulted in speculation that drove the exchange rates of Gulf currencies, especially the Saudi riyal and the UAE dirham to record highs.

"This again proves that under the fixed peg scenario there is little room for manoeuvrability for central banks as far as interest rates are concerned. Any divergence in rates could lead to speculation that will result in heavy inflows and currency appreciation," said Simon Williams, an economist with HSBC.

The UAE central bank announced a 25 basis points rate cut on Wednesday from 4.5 per cent to 4.25 per cent on certificates of deposit through which it controls interbank lending rates. Saudi Arabia and Bahrain also reacted quickly to the Fed rate cut, reducing rates by a quarter of a per cent.

The Saudi and Bahraini central banks kept lending rates unchanged in an attempt to limit the impact of lower rates on inflation. While Saudi Arabia cut its reverse repurchase rate, which guides the return on bank deposits, it left the benchmark repo, the rate at which it lends to banks, unchanged. Bahrain cut its deposit rate and left lending rates steady.

Qatar tightens

Qatar opted to tighten lending by increasing the reserve requirement by 50 basis points while reducing deposit rates by 25 basis points.

"Although increasing the reserve requirement is a form of monetary tightening and an attempt to drain liquidity from the banking system, we believe it will need to be higher to stem the strong money supply and credit growth," said Monica Malik, an economist with EFG-Hermes.

Analysts said yesterday that the fresh round of rate cuts has once again confused the markets from the point of view of trying to control domestic inflation.

According to Marios Maratheftis, an economist with Standard Chartered Bank, with the dollar losing more than 35 per cent of its value over the past five years, imported inflation and food prices are rising and the lower interest rates are fuelling inflationary pressure by adding to the already-high money supply.

Gulf central banks may want to raise rates to slow inflation, yet are choosing to follow the Fed to maintain their currencies' pegs to the dollar. Inflation in Saudi Arabia rose to 5.4 percent in October. In the UAE, according to official estimates the inflation was at 9.3 per cent last year. "Given how low rates already are, I don't think this cut is going to make any big difference to domestic inflationary trends, but it's certainly not what the Gulf needs," said Williams.