China looms large on GCC interest rates

Comment The links between the currencies of the GCC and the US essentially gives us a one-size-fits-all monetary policy.

The links between the currencies of the GCC and the US essentially gives us a one-size-fits-all monetary policy. By following the US Federal Reserve, short-term interest rates in the UAE have broadly chased the federal funds rate. If and when the US tightens, all indications are that the GCC will follow suit. Notwithstanding the differentiated macro-economies and incongruous inflation expectations, it seems the GCC may well wait on the US before it makes any move this time around.

However important is the US to the region's markets, we would like to draw attention to the bigger picture. The current story lies in Chinese tightening. It was reported last week that the People's Bank of China (PBoC) raised the reserve requirement ratio for its banks by 0.5 per cent, probably marking the onset of a long and winding phase of monetary contraction, especially given China's resistance to appreciating its yuan.

For all we know, China may choose to continue tightening, pre-empting an overheating economy, while quantitative easing continues in the US. Current rates of US resource utilisation as well as inflation trends and expectations continue to warrant a loose monetary policy for a period conceivably extending beyond the middle of this year. This may well leave us a with a window of three to six months, during which PBoC tightens but not the Fed.

Lately, China has been the primary driver of increases in global liquidity. Once that slows, it could trigger a re-pricing of assets globally. Chinese tightening, or the expectations of it, may set the agenda for a broad correction in prices of risky assets, with ripples spreading from the Pacific Rim to all emerging markets and then globally. As risks for equities and commodities could lie on the downside, a Chinese monetary tightening could create a challenging situation for the region. The Gulf equity markets have diverted from their Asian counterparts during the recovery phase as home-grown risk factors surfaced.

In the absence of a strong home-grown catalyst, the region's markets are still looking for the impetus they need to continue normalising. The question is whether any renewed bearishness in risky assets will be shadowed by the GCC equity markets, thus putting off their rally for a while. Dr Salwa Hammami Labib is the senior economist and Nick Groene is the director of treasury at Arqaam Capital.

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