Gulf region braced for US interest rate rise

The move will reverberate across the global economy and hit Gulf countries that have tied their monetary policies to the US.

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Larry Summers, the former US treasury secretary, cautioned against assuming that the dollar would rise following a widely anticipated interest rate hike.

The Federal Reserve is expected to raise interest rates for the first time in a decade in a move that could reverberate across the global economy and hit Arabian Gulf economies with currencies pegged to the dollar.

“What happens to the dollar going forward depends on in what direction the Fed surprises. The assumption that the dollar will rise because the Fed is going to tighten is the biggest mistake market participants are making right now,” Mr Summers said at an event in Dubai.

UAE banks’ cost of funding has already started to increase as institutions price in the rate rise. The three-month Emirates Interbank Offered Rate, which tracks the cost of short-term lending between UAE banks, has risen by 45 per cent – from 0.677 per cent to 0.985 per cent – since the start of the year, as banks anticipate increases in their funding costs.

This is likely to help banks to swell margins, and could lead to higher loan prices, analysts say.

The Federal Open Markets Committee, which sets the US interest rate, is expected to vote to increase rates from the range of 0 to 0.25 per cent to between 0.25 and 0.5 per cent. This small increase in the domestic cost of lending for American banks will push up borrowing costs the world over, as central banks tied to the dollar are forced to follow suit – or experience speculative pressure on their exchange rates.

The UAE, Qatar, Saudi Arabia, Bahrain and Oman have all pegged their currencies to the dollar. Kuwait pegged the dinar to a basket of currencies in 2007. Qatar’s central bank governor, Sheikh Abdulla bin Saud Al Thani, said in October that the country would not raise interest rates in response to a Fed rate hike. Qatar’s central bank did not cut rates to the same level as the Fed after the 2008 financial crisis, the reasoning went – so would not have to raise rates as quickly.

Other Gulf states may not have the same luxury. Saudi Arabia has already had speculative movements in forwards markets for the Saudi riyal, priced in dollars, which suggest investors believe that a devaluation of the currency is more likely. When the kingdom chose not to follow the US in lowering rates in 2006, the riyal appreciated dramatically against the dollar. But it is not clear whether higher US interest rates would lead to a stronger dollar and pegged currencies. The strong dirham has hit economic activity in Dubai as the emirate becomes more expensive to many visitors.

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