A move to raise US interest rates in December could fire the “starter’s gun” on increases in the costs of loans in the UAE.
Minutes from the last meeting of the Federal Reserve’s Open Markets Committee, which sets interest rates, were released yesterday, and contained a clear indication that December will be the date that the Fed moves the US funds rate above zero for the first time since 2008.
Bank net interest margins – the gap between their borrowing costs and lending prices – will increase marginally following a rate rise. That is because a change in interest rates allows banks to reprice their loans, analysts said.
Because banks knew that the Fed funds rate was set to increase, they did not want to raise borrowing prices before the Fed moved, for fear of losing market share, said Sanyalaksna Manibhandu, senior analyst at National Bank of Abu Dhabi. But a December rise in rates will be “the starter’s gun for banks and lenders to reprice their loans”, he said.
Banks with large numbers of current and savings account holders, which pay low rates of interest, will benefit, as will banks with high loan-to-deposit ratios.
Government deposits, which have been falling as the low oil price leads to lower revenues and higher cash flow needs at public sector companies, are unlikely to return to banks in response to a higher interest rate, however.
“Higher rates alone won’t do it – deposits aren’t growing because of low crude revenues,” Mr Manibhandu said. “It will have to be a matter of policy – for instance, if Gulf sovereigns repatriate funds held abroad, and recycle that back into the domestic economy.”
Jaap Meijer, head of research at Arqaam Capital, said that deposit withdrawals are likely to slow in the future, as governments and GREs tap bond markets to address financing needs instead of liquidating deposits. But an increase in domestic interest rates “won’t tempt deposits back”, he said.
Credit to private sector companies may slow further as banks become more cautious and borrowers choose to defer investment projects amid lower returns. “Lending hopefully will become a bit more efficient – where both sides look more closely at the expected returns from a project,” Mr Manibhandu said.
The relatively small interest rate change, an expected increase in lending costs of 0.25 per cent, will not have a major impact on the cost of finance, Mr Meijer said – meaning that its impact on corporate lending will be low. “The sensitivity of loan growth to a small change in the Fed rate is not that high,” he said. “Credit demand has definitely slowed down, but it’s a business cycle effect, not an interest rate effect.”
Rising interest rates are expected to further slow Dubai real estate, as an appreciating dirham pushes up home prices for foreign buyers, and mortgage finance becomes more expensive.
The dirham, which is pegged to the dollar, has risen by more than 25 per cent against a basket of international currencies since June last year. With US interest rates set to rise, and further bouts of quantitative easing scheduled in Europe and expected in Japan, the dollar is likely to rise further against foreign currencies.
“Anything which is going to impact the strength of the dollar is a potential negative for Dubai’s housing market, given the dollar peg,” said Matthew Green, head of research at CBRE.
A stronger dollar “makes Dubai a more expensive place to visit and buy”, Mr Green added. “There have been big swings against the euro and the rouble – key source markets for investment in Dubai residential properties. That’s where you have see a particular effect.”
Higher mortgage finance costs are unlikely to make a major dent in demand, however, because sizeable numbers of Dubai buyers continue to pay with cash.
“A longer-term shift in rates with a significant impact on the cost of finance could have an influence on sales,” Mr Green said. “But for now, the change in the dollar is much more important than changes in the cost of finance.” Mortgage costs are still lower than those in the run-up to Dubai’s 2009 property bust, Mr Green pointed out.
Monica Malik, chief economist at Abu Dhabi Commercial Bank, said that a rise in interest rates would have “a relatively small effect” on Dubai’s property market.
“The critical point about Fed minutes is that interest rate cycle will be gradual,” with interest rates set to remain low in historical terms for a number of years. “Housing will remain a healthy sector for encouraging investment,” she said.
“Most of the demand is domestic, and comes from new household formation, which shouldn’t be affected.”
abouyamourn@thenational.ae
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