Fed rate cuts will increase pressure on Gulf countries

Dubai: Interest rate cuts expected imminently by the US Federal Reserve in the range of 0.75 per cent to 1.25 per cent are putting additional pressure on GCC central banks to reform their monetary policies, anchored on the dollar peg, according to economists and analysts.

The Fed's key rate has already fallen from 5.25 per cent in September to 3 per cent. The pace picked up in January when the Fed slashed the rate by 1.25 percentage points.

Amidst expectations of further cuts, the Fed announced on Sunday that it was cutting by a quarter-point to 3.25 per cent its discount rate, the primary credit rate offered at the Fed's discount window for loans to institutions.


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"US interest rate cuts will definitely increase the pressure on GCC central banks. Although it might intensify the call for revaluation of some currencies such as the UAE dirham and Qatari riyal, the solution lies in anchoring the exchange rates against a basket of currencies," said Simon Williams, chief economist at HSBC Middle East.

In the context of expectation that the Fed will cut rates by another 1.25 per cent today, speculation is rising on many regional currencies. Reuters reported yesterday that one-year UAE dirham forwards slid to a record deep discount, reflecting speculation of a revaluation against the plummeting dollar, while Kuwait's currency rose to a record high.

Bankers confirmed yesterday that there has been an increase in speculation on the dirham. "The trend will continue until the central bank makes its position clear. Last week there were reports that it has launched a study into revaluation. This has heightened the expectations," said the head of treasury at a local bank.

Although the Gulf countries are facing a highly inflationary situation, econ-omists said the regional central banks would be forced to follow the US rate cuts. "The most likely scenario would be that most GCC central banks would cut deposit rates while keeping the lending rates unchanged," said Monica Malik, director of economics with EFG Hermes, an investment bank.

Economists said the Gulf states have reached a stage where they will have to delink their currencies from the dollar sooner rather than later. "The negative real interest rates, combined with rising inflation, will continue to exert pressure on the dollar pegs and further raise currency reform on the agenda of policymakers. Inflation levels will remain high. We continue to maintain our stand that there is a 60 per cent chance of revaluation in the first half of this year," said Malik.