Inflation is expected to rise to 3.3 per cent in the UAE as the five-per cent value-added tax (VAT) in place since January and higher oil prices will trickle down to make goods and services dearer, BMI said in a report.
The latest forecast from the Fitch subsidiary is a revision of its earlier estimate of 3.1 per cent after BMI updated Brent pricing to $65 per barrel for 2018 from $57 previously.
"This will lead to an increase in transportation prices - 10 per cent of the CPI [consumer price index] basket - given that fuel prices have been deregulated since 2015. Higher oil prices will also support domestic demand, putting upward pressure on inflation," the report said.
Saudi Arabia and the UAE - the region's biggest economies - introduced VAT in January to narrow fiscal deficits that had widened over the last couple of years as oil prices fell from $115 per barrel in 2014 to just under $30 in the beginning of 2016. The slump in the oil market has also pushed through a more aggressive diversification programme in these economies, with Saudi Arabia, the world's biggest oil exporter looking at privatisation initiatives, including the planned sale of a 10 per cent stake in cash-cow Saudi Aramco this year.
BMI expects the UAE central bank to follow a tighter monetary policy similar to that of the US Federal Reserve, which is expected to raise interest rates this year.
Hikes of three 25 basis point (bps ) are expected this year in line with the reserve taking the UAE’s repo rate to 2.5 per cent by the end of the year.
"Higher rates will help contain demand-pull inflationary pressures, but will do little to reduce price pressures stemming from fiscal measures and higher commodity prices," the report said.
The UAE is also expected to maintain its peg to the dollar - which has lost two and a half per cent of its value against other currencies this year - pushing up the price of commodities including crude and gold.
Higher rates, however, will be required to maintain the peg this year in order to encourage capital inflows and maintain investor confidence in the event of a narrowing rate differential, BMI added.