The Central Bank of the UAE increased its benchmark interest rates by 25 basis points mimicking the US Federal Reserve, which increased on Wednesday its rates for the second time in 2018, with two more expected this year.
The UAE's central bank hiked the interest rate to 2.25 per cent on its certificate of deposits, which it uses as a monetary policy instrument through which changes in interest rates are transmitted to the UAE banking system, the regulator said in an emailed statement on Thursday.
"Effective Thursday, 14 June 2018, it [central bank] will raise interest rates applied to the issuance of its certificates of deposits in line with the increase in interest rates on US dollar," the central bank said.
The repo rate applicable to borrowing short-term liquidity from the central bank against certificates of deposits has also been increased by 25 basis points to 2.25 per cent, it added.
The US Federal Reserve increased on Wednesday its target range for the federal funds interest rate by a quarter point, to between 1.75 per cent and 2 per cent. The move reflects the US economic momentum, Fed chairman Jerome Powell said following the decision. The Federal Open Market Committee indicated that even though it us stepping up the pace of interest-rate hikes for 2018 and 2019, economic growth should continue apace.
Central banks in the region, which peg their currencies to US dollar with the exception of Kuwait, don’t always raise or cut rates on each specific occasion when the Federal Reserve does, but they usually follow it in its broad outline over the long run.
The Saudi Arabian Monetary Authority also raised its benchmark rates late on Wednesday. The kingdom's central bank said it is increasing its repo rate, at which it lends to banks, by a quarter point to 2.5 per cent. The reverse repo rate, was also raised by 25 basis points to 2 per cent.
Bahrain's interest rate on the one-week deposit facility was raised to 2.25 per cent from 2 per cent.
The central bank of Bahrain also raised its key policy interest rate on the one-week deposit facility to 2.25 per cent from 2 per cent. The central bank of Kuwait, however said that it is maintaining its discount rate unchanged at 3 per cent.
Qatar's central bank said it would raise its deposit rate by 25 basis points to 2 per cent.
There was no immediate announcement from Oman.
The rising rates come at a time when the global economic growth is being tested by escalating trade tensions between the US, its European Union counterparts, Canada, Mexico and China. The International Monetary Fund and the World Trade Organisation have already voiced concern about the impact of tit-for-tat trade tariffs on global commerce. There are also concerns about the impact of Fed rate hikes on some of the emerging market economies, which may struggle in the wake of higher US borrowing costs.
The timing of monetary tightening and the rise in borrowing costs is also critical for the energy-dependent economies of the Arabian Gulf region, which are recovering from a slowdown on the back of the three-year oil price slump.
“Higher domestic interest rates are a headwind for the GCC’s economic outlook, given that the bloc’s business cycle is out of sync with the US,” said Bilal Khan, senior Mena and Pakistan economist at Standard Chartered. “For instance, although the recent rise in global oil prices has seen liquidity conditions in many GCC economies improve, private credit offtake remains lacklustre."
Razan Nasser, senior economist at HSBC Bank Middle East agreed, saying the “the higher cost of borrowing and the US dollar’s strength should continue to weigh on private credit growth and the competitiveness of the UAE’s export services.”
Given that the economies in the region are still rebounding, tighter monetary policy needs to be compensated with looser fiscal stance and economic stimulus, according to economists.
Last week, Abu Dhabi revealed a three-year, Dh50 billion stimulus package and 10 initiatives that will create jobs, boost economic growth in the emirate, increase consumption, bolster small and medium-sized businesses, and relax regulations for businesses. These initiatives follow other steps aimed at propelling growth in the emirate by buoying the non-oil sectors. Dubai earlier announced measures to waive certain administrative fines for companies to increase the competitiveness of the emirate.
Ms Nasser said the package announced by Abu Dhabi could help offset some of the impact of the monetary tightening, however, “the extent of that relief would depend on the timing and allocation of that stimulus”.
The size of the stimulus is around 6 per cent of the emirate’s GDP over three years and the economic impact could be positive, particularly given that job creation appears to be a key focus, according to Mr Khan.
“As such, we think the recent policy announcements from Abu Dhabi and Dubai to use countercyclical fiscal measures to support non-oil growth is an appropriate response at this stage,” he said.