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Most GCC central banks raised interest rates with effect from Thursday (September 27) following a 0.25 per cent increase in interest rates by the US Federal Reserve on Wednesday. The Fed rate hike was widely anticipated in the context of improved US macroeconomic data.

The Fed’s latest forecast predicts that the unemployment rate, now 3.9 per cent, will reach 3.7 per cent by year-end and 3.5 per cent next year. It foresees the economy growing 3.1 per cent this year before slowing to 2.5 per cent in 2019.

“Given that US unemployment figures are at multi-year lows and inflation has been at levels acceptable to the Fed for some time now, the market had largely factored in this increase,” said Emilio Pera, Partner and Head of Audit at KPMG Lower Gulf.

GCC central banks track US interest rates as all them, except Kuwait, have currencies pegged to the dollar, giving them little room for monetary policy divergence. It is important to maintain interest rates at par or in close range with US rates to prevent capital flight in the event of higher rates offered on dollar deposits.

The Central Bank of the UAE (CBUAE) said late on Wednesday it was raising its repo rate by 25 basis points, and also raising interest rates on the issuance of its certificates of deposits (reverse repo) in line with the increase in dollar rates.

The Saudi Arabian Monetary Authority (SAMA) raised its reverse repo rate by 25 basis points to 2.25 per cent, and its repo rate by the same margin to 2.75 per cent. While the central banks of Bahrain and Qatar too announced 0.25 per cent increase in lending and deposit rates, Kuwait’s central bank decided to keep its key discount rate unchanged at 3 per cent, as its currency’s exchange rate is managed against an undisclosed basket of currencies.

“Recent data has shown the central bank is able to maintain a stable margin between rates on dinar and dollar deposits to keep the local currency attractive to investors, and also a stable margin between banks’ dinar loan and deposit rates,” said Mohammad Al-Hashel, Kuwait’s central bank governor said in a statement.

GCC central banks and commercial banks say the rise in rates is gradual and the banking systems are sufficiently liquid. “The fact that the increase is gradual gives a lot of comfort to SAMA to address any issues that could come up in the local liquidity system — something that we have not witnessed so far because liquidity is ample,” Ayman Bin Mohammad Al Sayari, SAMA’s deputy governor for investment had said earlier this month.

Rising rates along with rising dollar is likely to increase cost of funds for local corporates, small businesses and retail borrowers. Although a rising dollar is likely to bring some respite to imported inflation, analysts say, it could have adverse impact on sectors such as tourism, retail and hospitality that could become dearer and less competitive of the local currency’s peg to the dollar.

Higher interest rates are expected to improve the profitability of GCC banks from higher interest rate margins.

“The move will increase borrowing costs, and likely improve banks’ profitability, marking further improvement for the sector this year after the robust performance of 2017. The hope remains that the broader industry will absorb the higher costs buoyed by the oil price recovery and given the strong performance of loans and deposits growth in August,” said KPMG’s Pera.

While the US rate hike has not come as a surprise, its immediate impact on the GCC economies is minimal. However, the rate outlook from the Fed points to another hike this year and four more in 2019, implying the end of several years of easy money policy.

“This rate hike is no surprise, but the removal of the signal that policy is still accommodative will raise a few eyebrows,” said Aberdeen Standard Investments Senior Global Economist James McCann.

Economists said the Fed has been reluctant in forecasting inflation, instead it left the markets to guess its trajectory based on the available macro data.

“Normally you would expect fast growth and tight capacity (low unemployment) to send inflation higher. We suspect that the Fed is reluctant to forecast higher inflation because that would undermine confidence in its projections of a gradual and limited policy tightening,” said Richard Jerram, Chief Economist of Bank of Singapore.