UAE not as affected by inflationary pressures as some developed economies

For most of the last three years, consumer prices in the UAE have been declining

Abu Dhabi, UAE - October 19, 2008 - Grocery shoppers in the rice isle at Lulu Hypermarket. (Nicole Hill / The National) *** Local Caption ***  NH Lulu05.jpgNH Lulu05.jpg
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Inflation — and its implications for interest rates — will remain a key focus for financial markets this week, with US inflation data for January due to be released on February 10.

Analysts expect the headline rate to rise above the 7 per cent year-on-year seen in December, which was already a 40-year high.

The story is similar across many economies, including the UK and the euro zone, where consumer inflation surged above 5 per cent in January. The main drivers of inflation in the developed markets last year were energy prices, supply chain disruptions, reopening frictions and food prices.

However, not all countries have been affected to the same extent by these inflationary pressures. Chinese inflation is lower than it was pre-pandemic at 1.5 per cent year-on-year in December and Japan’s perennially low inflation remained sub-1 per cent at the end of last year.

In the UAE too, inflation has been much weaker over the last year than in most developed economies and some neighbouring ones.

For most of the last three years, consumer prices in the UAE as measured by the consumer price index (CPI) have been declining. It was only in August 2021 that the UAE’s annual inflation rate returned to positive territory, and rose to 2.5 per cent by the end of last year. This is still around half the inflation seen in Europe and around a third of the US inflation rate.

Housing (including utilities), transport and food together account for almost 63 per cent of UAE’s consumer basket, with housing alone accounting for just over one-third. Last year, housing and utility costs in the CPI declined by 3.5 per cent from 2020, which helped to offset some price increases in other components of the index.

While this may sound counterintuitive — real estate consultancies have reported average rents rising in the second half of 2021 — it takes time for changes in the market rates to feed through to the CPI.

Not all households are renewing leases at the same time, nor are rents for all units rising by the same amount. It can take 18 months to two years for changes in market rents and residential real estate prices to feed through to the CPI. As a result, we don’t expect significant upwards pressure from housing in the CPI this year either.

Utility prices in the UAE have also had less of an impact on inflation in the UAE than in North America and Europe, where gas is more common for residential use than it is here.

The biggest increase in the UAE’s CPI in 2021 was in the transport component of the index, which reached 18 per cent year-on-year by December and averaged a 9 per cent increase over the whole of last year. It is likely that the main drivers of this increase were petrol prices and vehicle costs, both of which have increased sharply over the last year.

UAE petrol prices had increased almost 48 per cent year-on-year by the end of last year, reflecting the higher price of crude oil in 2021. While petrol prices are likely to increase further in the short term — the February price rise was 11.5 per cent month-on-month — as oil prices remain elevated, we expect crude prices, and therefore, petrol prices at the pump to soften in the second half of the year.

New and used vehicle prices probably also contributed to the increase in transport costs for consumers in the UAE last year.

Once again, this was something of a global phenomenon as semiconductor chip shortages — a result of Covid-related lockdowns across Asia — meant car producers could not increase production fast enough to meet demand.

The shortage of new cars put upwards pressure on second-hand cars as well. While it will take some time for chip shortages to be fully resolved, supply is expected to recover this year, allowing vehicle manufacturers to boost production.

Higher global food prices started to feed through to the UAE in the final quarter of 2021, with food inflation in the UAE reaching 3.7 per cent year-on-year by December. The UN World Food Price Index shows that food inflation peaked in mid-2021 and had slowed to a still-high 19 per cent year-on-year by December 2021.

We expect food price inflation to continue to feed through to the UAE CPI over the course of this year as the UAE imports most of its food. However, food prices are typically very volatile and we do not anticipate a sustained increase in domestic rates — not least because we expect the US dollar to strengthen this year, mitigating some of the increase, and also because the UAE authorities can step in to stabilise the market through price caps and managing essential food supplies.

The other segments of the UAE CPI that recorded some increase in prices last year were mainly services. Recreation and culture prices increased 4.5 per cent on average last year as leisure activities normalised, after declining more than 16 per cent in 2020.

Education costs rose 1.1 per cent, health care was up 0.4 per cent, and hotel and restaurant prices rose just 0.7 per cent on average over 2020, even as most restrictions were lifted and tourism recovered in the final quarter of 2021.

To some extent, this relatively modest inflation reflected excess capacity in education, health care and hospitality sectors last year, and competition between businesses which have kept prices from rising more quickly.

Emirates NBD expects inflation in the UAE to accelerate in the first half of 2022 before slowing in the second half, with inflation likely to average between 2 per cent and 2.5 per cent over the whole year.

While high energy and commodity prices are likely to keep input costs for businesses elevated in the coming months, the PMI survey data suggests that most firms are absorbing these higher costs rather than passing them on to customers. That should help to keep consumer inflation contained.

Fed rate increases this year will underpin the dollar, keeping imported inflation into the UAE in check. Finally, supply chains are expected to improve over the course of the year, and shipping costs have already started to ease.

Khatija Haque is chief economist and head of research at Emirates NBD

Updated: February 07, 2022, 11:51 AM