UAE and Saudi Arabia follow Fed lead and cut interest rates

The Central Bank of the UAE and other regulators in the GCC economic bloc cut benchmark interest rates on Thursday after the US Federal Reserve lowered its key rates for a second time this year, without committing to lowering them further in 2019.

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 lowers by 25 bps.

The Fed reduced the federal funds rate target, its main policy rate, by a quarter-percentage point to a range of 1.75 to 2 per cent. The widely expected slashing of benchmark rates by the US central bank is its second downward revision in consecutive quarters. The rate cut in July was the first since the financial crisis, which came on the back of nine rate increases since 2015, when the Fed started gradually raising the cost of borrowing.

The Fed cited a strong labour market and rising economic activity in a statement on the move.

“We took this step to help keep the US economy strong in the face of some notable developments and to provide insurance against ongoing risks,” Fed chairman Jerome Powell, said.

The strength of the US economy pushed rates higher last year, however, recent US economic data sent mixed signals to the Fed with consumer spending and retail sales growth, an indication of consumer sentiment, weakening. There are, however, signs of strength in manufacturing activity and the labour market.

“We have a hawkish rate cut — meaning even though the Fed has cut the interest rate today ... there are no clear signals in relation to further rate cuts,” Naeem Aslam, chief market analyst at UK-based TF Global Markets, said in a research note. “In other words, the fed is no rush to cut the interest rate again.”

Most central banks in the GCC follow the Fed's moves on key interest rates because their currencies are pegged to the US dollar, with the exception of Kuwait, whose dinar is linked to a basket of currencies.

The Riyadh-based Saudi Arabian Monetary Authority lowered its repo rate from 275 bps to 250 bps, and its reverse repo rate from 225 bps to 200, saying the decision is consistent with Sama’s objective of preserving monetary stability amid “evolving developments in global financial markets”.

Kuwait's banking regulator said it is keeping its discount rate unchanged at 3 per cent.

"The rate cuts could not have come soon enough for the GCC," Bilal Khan, executive director of research for Middle East, North Africa and Pakistan at Standard Chartered, said. "The switch from hikes until the end of last year to cuts finally allows (some) GCC central banks to use monetary policy to counter the business cycle. While, on the margin, this is welcome relief ..... government spending still plays an out-sized role in driving GCC economic activity."

The Fed, which adopted a more dovish stance and paused rate hikes in 2019, raised rates last year despite the ongoing US-China trade war threatening the US and global growth, forcing the International Monetary Fund and The World Bank to cut estimates for world economic growth this year.

Mr Powell on Wednesday said that “moderate” policy moves should be sufficient to sustain the US economic expansion, which prompted a Twitter tirade from US President Donald Trump.

"Jay Powell and the Federal Reserve Fail Again. No "guts," no sense, no vision! A terrible communicator!" Mr Trump tweeted.

Mr Trump has consistently and openly heaped pressure on the country’s central bank and on Mr Powell, in particular, through repeated statements and fiery tweets.

The president, who is campaigning for 2020 re-election has argued for more aggressive interest rates cuts to compete with other countries that have lower rates.

Despite the Fed not clearly guiding the market on further rate lowering this year, financial markets expect this to happen in the forthcoming meetings in October and December.

“We believe, with limited confidence, that there could be another rate cut of 25 basis points at the October meeting," said David Kohl, chief currency economist, at Julius Baer. "The rather hawkish rate cut consolidates marginally the support for the US dollar."

James McCann a senior economist with Aberdeen Standard Investments said while he expects the Fed to deliver 25bps cuts in October and December, "there is a clear risk that the Fed opts to pause at the next meeting before moving in December ... this would push the final move into Q1 next year, at which point the fed funds target range would bottom at 1.25-1.5 per cent."