The Central Bank of the UAE and other Arabian Gulf regulators cut benchmark interest rates following the US Federal Reserve's decision on Wednesday to reduce its key rates for the first time in more than a decade, indicating a willingness for further cuts.
The banking regulator in the UAE reduced the interest rate by 25 basis points (bps) on its certificate of deposits, the monetary policy instrument through which changes in interest rates are transmitted to financial institutions.
The rate reduction is effective from Thursday, which is also when the repo rate on borrowing short-term liquidity from the central bank against certificates of deposits goes down by 25 bps, the central bank said.
The Fed reduced the federal funds rate target by a quarter-percentage point to a range of 2 to 2.5 per cent. The move, widely anticipated by economists and the markets, follows four consecutive rate rises last year with a quarter-point hike in December the ninth increase since 2015, when it started gradually increasing the cost of borrowing.
The strength of the US economy drove the consistent rate hikes but the US central bank paused monetary tightening in April and turned dovish in June.
The Fed cited "the implications of global developments for the [US] economic outlook" as well as muted inflation pressures in the country as the reasons to lower rates. The US central bank said it "will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion."
Most GCC central banks follow the Fed's moves on key interest rates due to the peg of their currencies to the US dollar, with the exception of Kuwait, whose dinar is linked to a basket of currencies.
Saudi Arabian Monetary Authority lowered its repo rate from 300 bps to 275 bps, and its reverse repo rate from 250 bps to 225 bps with an "objective of preserving monetary stability", it said in a statement on its web site.
The Central Bank of Bahrain also slashed the interest rate on its one-week deposit facility to 2.5 per cent from 2.75 per cent. It also reduced the overnight deposit rate to 2.25 per cent from 2.5 per cent; the one-month deposit rate to 2.85 per cent from 3.1 and its lending rate to 4.25 per cent from 4.5.
Kuwait's banking regulator said it is keeping its discount rate unchanged at 3 per cent.
Until last year the Fed had raised rates despite intensifying US-China trade tensions which are impeding the global economy's growth and forced the International Monetary Fund and The World Bank to repeatedly revise down their outlook estimates this year.
Fed chairman Jerome Powell said the rate cut was a measure to “insure against downside risks” rather than a sign of continued monetary policy easing.
“We’re thinking of it as essentially in the nature of a mid-cycle adjustment to policy,” he said at a press conference. “It’s not the beginning of a long series of rate cuts.”
Mr Powell however, indicated that the quarter percentage point reduction in key rate is not "just one”, signalling other cuts may follow possibly the fourth quarter of this year.
"We believe that Powell’s characterisation of this easing cycle as a 'mid-cycle adjustment' should be not interpreted as a one-and-done," said Eli Lee, head of investment strategy and Bank of Singapore.
US President Donald Trump, who has been advocating for a larger rate cut, welcomed the Fed decision but criticised Mr Powell in a tweet for not beginning “a lengthy and aggressive rate-cutting cycle which would keep pace with China, the European Union and other countries”.
“As usual, Powell let us down,” Mr Trump said.
The US dollar hit a two month high against most currencies following the Fed's decision. The S&P 500 fell as much as 1.7 per cent intraday and closed down 1.1 per cent.
For hydrocarbon-intensive Arabian Gulf economies, lower interest rates are a good omen as it stokes the potential of lending growth in the region, Monica Malik, chief economist at Abu Dhabi Commercial Bank, said.
"We see the rate cut as positive for the GCC region, given the overall soft growth and inflation backdrops. It will help to counterbalance some of the monetary tightening in end-2018, though rates are still higher than in early 2018," Ms Malik said.
"Wider factors, such as momentum in growth or economic headwinds, will remain critical for loan demand alongside the interest rate," she noted.
Bilal Khan, executive director for Middle East, North Africa and Pakistan at Standard Chartered global research echoed Ms Malik's sentiments, saying the rate cuts are likely to be welcomed in the region, particularly in the two biggest Arab economies - Saudi Arabia and the UAE - where consumer-price deflation had driven real interest rates higher in recent months.
"The decision by most GCC central banks to mirror the Fed’s 25 bps cut is in line with our expectations. Looking ahead, we expect one further rate cut this year," Mr Khan said.
"At the margin, rate cuts should reduce an additional headwind to the non-oil sector outlook from an unwarranted tightening of financial conditions," he noted.
While lower rates are good for the economy and may encourage corporate and sovereign issuers to tap the debt markets, it is not so good for lenders in the region who have benefited from higher interest rates over the past few years.
"For GCC banks, particularly KSA [Saudi Arabia], we expect an inflection point in NIMs [net interest margins], the key driver of earnings since the first quarter of 2017," EFG Hermes said in a note to investors.