Gulf central banks raise interest rates as Fed stays course

US Federal Reserve increases key policy rate by 25 basis points amid crisis that has led to collapse of three lenders

The Dubai skyline. The UAE economy is expected to register strong growth this year, after expanding at its fastest pace in 11 years in 2022. AFP

The central banks of the UAE, Saudi Arabia, Bahrain and Qatar raised their benchmark borrowing rates after the US Federal Reserve increased its key interest rate at a more moderate level as it tries to balance fighting inflation and financial stability.

The Fed increased the policy rate by 25 basis points as it continues its push towards bring inflation down to its target range of 2 per cent and restore price stability amid market turmoil fuelled by recent bank failures in the world's largest economy.

This is the ninth rate increase by the US central bank since it started monetary tightening last March, pushing rates in the US to their highest since 2007, just before the 2008 financial crisis.

Most central banks in the GCC follow the Fed's policy rate moves due to their currencies being pegged to the US dollar. Kuwait is an exception in the six-member economic bloc as its dinar is linked to a basket of currencies.

The Saudi Central Bank, better known as Sama, raised its repurchase agreement (repo) rate by a quarter-point to 5.50 per cent and its reverse repo rate by a similar margin to 5 per cent.

The kingdom's inflation rate for 2022 was estimated at 2.6 per cent and, according to preliminary forecasts, has been forecast at 2.1 per cent in 2023, Saudi Finance Minister Mohammed Al Jadaan said in December.

The UAE Central Bank raised its base rate for the overnight deposit facility by a quarter of a percentage point to 4.9 per cent, effective from Thursday.

It maintained the rate applicable to borrowing short-term liquidity from the regulator through all standing credit facilities at 50 bps above the base rate.

The base rate, which is anchored to the Fed's interest on reserve balances, signals the general stance of the UAE regulator’s monetary policy and provides an effective interest rate floor for overnight money market rates.

The UAE economy is estimated to have grown by 7.6 per cent last year, the highest in 11 years, after expanding 3.9 per cent in 2021, according to the UAE Central Bank. The country’s economy is projected to grow 3.9 per cent in 2023, according to the regulator.

Inflation in the Emirates — stoked by increasing energy prices, imported inflation and rising employment — was projected at 4.9 per cent in 2022, according to the Central Bank's Quarterly Economic Review 2022.

That compares with a global inflation rate of 8.8 per cent last year, according to International Monetary Fund estimates.

The Central Bank of Bahrain also increased its key rate on one-week deposits by 25 bps to 5.75 per cent.

The Bahraini regulator raised its interest rate on overnight deposits by a quarter-point to 5.50 per cent, and by a similar margin on its four-week deposit rate, raising it to 6.50 per cent. The lending rates remain unchanged at 6.75 per cent.

The Central Bank of Qatar raised its repo rate by a quarter of a percentage point to 5.50 per cent. It also increased its deposit rate by a similar margin pushing it to 5.25 per cent and the lending rate by 25 bps to 5.75 per cent.

Inflation in GCC economies remained lower than the global average, benefiting from fixed exchange rates and fuel subsidies, according to the World Bank.

Global inflation is forecast to fall to 6.6 per cent in 2023 and 4.3 per cent in 2024, according to the IMF's latest forecast.

Higher oil prices and Russia's war in Ukraine exacerbated inflation in 2022.

A strong US dollar also increased the price of imports and food costs globally last year, but the greenback began to depreciate in September, a situation that is expected to help in easing inflationary pressures further in 2023.

Mena economies — which expanded by about 5.7 per cent in 2022, their highest in a decade, owing to a rise in energy revenue — are projected to decelerate to 3.5 per cent in 2023 and to 2.7 per cent in 2024, according to the World Bank.

GCC economies are projected to have grown 6.9 per cent in 2022, on the back of high oil prices and higher growth rates in non-oil sectors.

Growth in GCC countries is expected to slow to 3.7 per cent in 2023 and 2.4 per cent in 2024, owing to lower oil prices.

Financial stability risks complicate the Fed's efforts to tackle inflation, as it has to stay the course with its monetary policy of tightening to cool the job market while reducing prices without exacerbating the situation — a delicate balancing act.

A banking crisis in the US sparked by the collapse of Silicon Valley Bank has deepened with the demise of Signature Bank and Silvergate Capital, and left First Republic Bank on the brink of collapse.

“The US banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring and inflation,” the Federal Open Market Committee said on Wednesday.

“The extent of these effects is uncertain. The committee remains highly attentive to inflation risks.”

While the Biden administration has said the US banking system “remains resilient and on a solid foundation”, the world's largest economy is now expected to slide into a recession in 2023, according to Moody's Investors Service and Goldman Sachs.

“Problems in the US banking system are contributing to tighter credit conditions in the US, thereby increasing growth risks in the coming months,” said David Kohl, chief economist at Julius Baer.

“At the same time, a Fed that is more mindful of the fact that monetary policy is already quite restrictive and is showing its effect reduces the risk that monetary policy will be overtightened and that the US economy will be pushed into a recession in the next 12 months.”

The risk of an international spillover is low due to the strong balance sheets of European lenders, ample liquidity and the limited exposure of financial institutions elsewhere, which has helped to contain the contagion from distressed US banks.

“Authorities have reacted swiftly and decisively to contain financial stress, including co-ordinated central bank action to support global liquidity,” said Stephane Monier, chief investment officer of Lombard Odier Private Bank.

“The current situation looks very different from that in early 2008, when the global financial crisis was brewing.

“Banks have bigger capital buffers, particularly the largest banks, where capital requirements were increased significantly [after the global financial crisis].

“They have less exposure to subprime mortgages and commercial real estate. Regulation has been reinforced and regulators have learnt lessons about the importance of swift and decisive action.”

The situation is more about a crisis of confidence in US lenders, rather than one involving a liquidity crunch as was the case in the 2008 financial crisis.

The Fed also said it anticipates that “some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive” to return inflation to 2 per cent.