UAE Central Bank holds base rate as Fed hits pause

US inflation eased to its lowest level since early 2021

The Abu Dhabi skyline. Reuters

The UAE Central Bank maintained its benchmark borrowing rate as the US Federal Reserve paused its tightening cycle after having increased interest rates to their highest in 16 years to tame inflation and restore price stability.

The Fed, which increased its benchmark rate for the tenth consecutive time last month, maintained it range of 5 per cent to 5.25 per cent.

The Fed has raised rates by combined 500 basis points over the past 15 months, their highest since 2007, shortly before the start of the 2008 global financial crisis. It is pausing now to assess the effects of the tightening cycle on the economy.

The US central bank has raised rates aggressively to bring inflation down to its target range of 2 per cent after prices hit a four-decade high of 9.1 per cent in June of last year.

Data released on Tuesday showed that US inflation had cooled to an annual 4 per cent in May, from 4.9 per cent, the lowest level since March 2021. Meanwhile, core inflation, which excludes food and energy, softened to 5.3 per cent, from 5.5 per cent.

The latest reading from the US on prices "laid the foundation for no action from the Fed today in terms of an interest rate hike" said Naeem Aslam, chief investment officer at Zaye Capital Markets.

"Traders would like to see the Fed take the summer off and sit on the beach. They have been increasing the interest rate very aggressively, and the fruit of their labour is clearly showing in the inflation data.

David Kohl, chief economist at Julius Baer said the Swiss bank expects "further tightening of US credit dynamics in the coming weeks and lower inflation readings in the coming months, which should convince the Fed to refrain from further rate hikes".

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

The UAE Central Bank kept its benchmark borrowing rate, its base rate for the overnight deposit facility, at 5.15 per cent.

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 (IORB), signals the general stance of the Central Bank’s monetary policy and provides an effective interest rate floor for overnight money market rates.

The UAE economy grew by about 7.6 per cent last year, the highest in 11 years, after expanding 3.9 per cent in 2021.

It is projected to grow 3.9 per cent in 2023 and 4.3 per cent in 2024, according to the Central Bank.

Inflation in the Emirates was 4.8 per cent in 2022 and is projected at 3.2 per cent and 2.8 per cent in 2023 and 2024, respectively, according to the Central Bank's Quarterly Economic Review 2022.

That compares with a global inflation rate of 8.7 per cent in 2022. Global inflation will decrease to 7 per cent this year and 4.9 per cent in 2024, according to International Monetary Fund estimates.

In April, the Institute of International Finance projected an even lower UAE inflation rate of 2.4 per cent in 2023, supported by lower global commodity prices and manufacturing unit value.

Despite tighter global financial conditions, the UAE's non-hydrocarbon real growth will remain strong at 4.8 per cent this year, the Washington-based institute said.

That is above the 4.2 per cent estimate of the Central Bank for this year and the 4.6 per cent forecast for 2024.

Annual oil gross domestic product growth has been forecast at 3 per cent and 3.5 per cent in 2023 and 2024, respectively, according to the Central Bank.

“Rising interest rates will have limited impact on economic activity in the UAE,” the IIF said.

UAE banks remain adequately capitalised while the loan-to-deposit ratio edged down to 86 per cent in December 2022, according to the IIF.

Net foreign assets of commercial banks more than doubled to $104 billion at the end of 2022.

The Emirates remains the main regional destination of foreign direct investment inflows, attracting about $22 billion in 2022 or about 4.4 per cent of GDP, one of the highest among emerging economies, according to the IIF.

The Central Bank of Qatar also held its policy rate, with its repo rate maintained at 5.75 per cent, its deposit rate at 5.5 per cent and the lending rate at 6 per cent.