Central banks of Gulf states cut benchmark interest rates following the US Federal Reserve's decision to reduce its key rates to offset the impact of the coronavirus on its economy, after a tumultuous week for markets that wiped out $7 trillion of global stocks and put further downward pressure on oil prices.
The higher-than-expected 50 basis points (bps) cut by the US central bank is the biggest since the 2008 financial crisis. The last time the Fed made an emergency interest rate cut was more than a decade ago. The decision sent the yield on the US Treasury note, a key benchmark for borrowing and savings rates globally, fell for the first time in history below 1 per cent to 0.999 per cent.
The Central Bank of the UAE also slashed interest rate on its certificate of deposits by 50 bps, the regulator said on Tuesday evening. Certificate deposits are monetary policy instruments through which changes in interest rates are transferred to financial institutions. The reduced rates are effective from Wednesday when the repo rate applicable to borrowing short-term liquidity from the Central Bank also go down by 50 bps, the regulator said.
On Tuesday, the Fed reduced the fed funds rate by half a percentage point to a target range of 1 per cent to 1.25 per cent as it looks to shield the world’s largest economy and its longest-ever economic expansion run due to the effects of the coronavirus outbreak.
“The fundamentals of the US economy remain strong. However, the coronavirus poses evolving risks to economic activity,” the Fed said. "[We] are closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy," it added.
US equities fell 3 per cent following the surprise cut from the Fed. "It appears that the move rather frustrated investors who were expecting a more creative, or impactful action than a simple rate cut, which they thought wouldn’t remedy to disrupted supply chain problems," said Ipek Ozkardeskaya, senior analyst at Swissquote Bank "We have a real issue here: investors are expecting central bankers to become the heroes that they are not meant to be."
The Fed announcement followed a pledge on Tuesday by finance ministers from the G7 group of countries to use “all appropriate tools" to deal with the spreading virus. The G7, which includes the US, Japan, Germany, Britain, France, Italy and Canada, said it was ready to take actions, including fiscal measures where appropriate, to respond to the virus and support their economies.
Most GCC central banks follow the Fed's moves on key interest rates due to their currency peg to the US dollar, with the exception of Kuwait, whose dinar is linked to a basket of currencies.
Saudi Arabia's Monetary Authority on Tuesday also cut its repo rate, which is used to lend money to banks, by 50 bps to 1.75 per cent. Sama’s reverse repo rate, at which commercial banks deposit money with the central bank, is also reduced by 50 bps to 1.25 per cent.
Bahrain's central bank cut the interest rate on the one-week deposit facility to 1.75 per cent from 2.25 per cent. The regulator also reduced the overnight deposit rate to 1.5 per cent from 2 per cent, and slashed the one-month deposit rate to 2.2 per cent from 2.45 per cent. It, however, left its lending rates unchanged at 4 per cent. Kuwait's central bank lowered its discount rate to 2.5 per cent from 2.75 per cent.
Growth concerns last week contributed to a meltdown of global equities and rattled the commodities market, while gold, a traditional haven for investors, rose to nearly $1700 an ounce. The precious metal was trading at $1637.35 on Wednesday at 11.38am UAE time.
“The Fed’s messaging suggests that this is not a 50 bps and done”, said Eli Lee, head of investment strategy at Bank of Singapore. “Judging from history, this language from the Fed against a backdrop of an external growth shock … signals more imminent cuts ahead.”
Although the G7 has committed to take action, the Fed is the only regulator so far to implement a cut. The markets are waiting to see what the European Central Bank will do on Wednesday.
“The Fed has proved today that it is willing to do whatever it takes to keep the bull market alive,” said Naeem Aslam, chief market analyst at Avatrade in London. The “cut has taken traders completely by surprise because no one was expecting this and especially this aggressive move. I think the floodgate is wide open and other central banks like that of Bank of Canada is also likely to follow the same path”.
The spread of the coronavirus, which has disrupted trade, global supply chains and brought Chinese factories to a virtual standstill, is threatening to derail the global economy.
The Organisation for Economic Co-operation and Development (OECD) earlier this week said growth could fall to the slowest pace since 2009, as the virus continues to spread. The organisation projects a 2.4 per cent economic expansion in 2020, down from its 2.9 per cent estimated in November and said a longer span of the outbreak could halve growth to 1.5 per cent and force a number countries into recession.
The International Monetary Fund and the World Bank on Tuesday also made a commitment to extend financial assistance and policy advice to countries in need. The virus has spread from Wuhan in China to more than 50 countries. The global death toll has risen beyond 3,000 and cases of infection have crossed 90,000, with the rate of those infected now higher in countries such as South Korea, Iran and Italy than in China.