UAE raises interest rates in line with Fed's biggest move in two decades

Fed's move to raise its key rate by half a percentage point is its second in less than three months

Most central banks in the six-member economic bloc of the Gulf Co-operation Council follow the Fed key interest rate moves due to their currency pegs to the US dollar. Antonie Robertson / The National

The Central Bank of the UAE raised the base rate applicable to the overnight deposit facility by 50 basis points, effective from Thursday, May 5, following the decision made by the US Federal Reserve Board to increase its key interest rate on Wednesday.

Most central banks in the six-member economic bloc of the Gulf Co-operation Council follow the Fed key interest rate moves due to their currency pegs to the US dollar, with the exception of Kuwait, whose dinar is linked to a basket of currencies.

The Fed's move to raise its key rate by half a percentage point is its largest increase since 2000 and its second in less than three months as the world's largest economy looks to curb soaring inflation, which hit the highest level since 1981.

The UAE central bank also decided to maintain the rate applicable to borrowing short-term liquidity from the regulator through all standing credit facilities at 50 bps above the base rate, it said in a statement on Wednesday.

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

In March, most of the region's central banks increased their rates after the Fed approved a quarter percentage point rise, following two years of keeping the rates near zero. The accommodative monetary policy to cushion the economy from pandemic shocks has pushed well above the Fed target of 2 per cent.

The Fed’s hawkish stance towards rate increases comes amid tumult in the global economy as well as energy and commodities markets volatility caused by Russia’s invasion of Ukraine.

Average petroleum spot prices have fluctuated between $98 and $130 per barrel since the conflict began and are expected to settle at about $107 per barrel in 2022, the International Monetary Fund said.

Food prices are expected to increase by about 14 per cent this year on top of the 28 per cent increase in 2021, it said.

The IMF forecasts Mena inflation will reach 13.9 per cent, slightly lower than the 14.8 per cent recorded last year, driven by a significant increase in food and energy prices, and in some cases, exchange rate depreciations and lax monetary or fiscal policies.

In the UAE, banks are expected to benefit from the rise in interest rates. Lenders' net income is estimated to increase 15 per cent, and return on assets to grow 1.4 per cent, for every 100 bps increase in interest rates, S&P Global Ratings reported.

Despite the interest rate increase, lending growth is likely to accelerate, underpinned by the UAE’s economic growth, the rating agency said.

However, with anywhere between seven and nine interest rate rises expected in 2022 and 2023, borrowing is likely to tighten in the longer term, Mohamed Abdelbary, Abu Dhabi Islamic Bank's group chief financial officer, told The National last month.

“There is demand and financing will happen, but as rates also go up, you will start seeing that some clients may be [holding] back from availing financing,” he said.

“It's early days for that, but our expectation is that the [lending] market is probably going to grow anywhere between 5 per cent and 7 per cent this year.”