Consumers will pay more to borrow money after the US Federal Reserve’s decision on Wednesday to raise interest rates by a more moderate 25 basis points as it continues to fight inflation amid market turmoil fuelled by the recent banking crisis, financial experts say.
The increase brings the Federal Open Market Committee's short-term rate to between 4.75 per cent and 5 per cent, the highest level in 16 years.
However, the banking crisis — sparked by the collapse of Silicon Valley Bank and Silvergate Capital in the US, and Credit Suisse in Switzerland — dampened the Fed's aggressive rate rise amid concerns that higher borrowing rates could lead to more volatility in the sector.
Central banks are no longer seeking to ensure “cheap money” is available for households, companies and governments to borrow at “exceptionally favourable rates” as they did during the Covid-19 pandemic, said Vijay Valecha, chief investment officer at Century Financial.
“During the pandemic, cheap money was provided to help the economy sustain itself. However, as economies are recovering gradually, the availability of quick money would reduce consumer spending as the cost of borrowing has increased,” he said.
Most central banks in the GCC follow the Fed's policy rate moves due to their currencies being pegged to the US dollar.
The UAE Central Bank also increased its base rate for the overnight deposit facility (ODF) by a quarter of a percentage point to 4.9 per cent, from 4.4 per cent, effective from Thursday.
It maintained the rate applicable to borrowing short-term liquidity from the regulator through all standing credit facilities at 50 bps above the base rate, the regulator said.
The base rate, which is anchored to the Fed's interest on reserve balances (IORB), signals the general stance of the UAE Central Bank's monetary policy and provides an effective interest rate floor for overnight money market rates.
Inflation in the UAE is relatively low compared with other parts of the world and was projected at 4.9 per cent in 2022, according to the Central Bank.
The Fed's rate increase comes amid an uncertain global economic outlook fuelled by record-high inflation and Russia’s worsening military assault on Ukraine that has affected commodities markets.
However, the strength of the UAE’s recovery from the pandemic means its economy is well placed to deal with higher rates, said Monica Malik, chief economist at Abu Dhabi Commercial Bank.
“Borrowing costs will rise further, with the Fed firmly focusing on inflation,” Ms Malik said.
Higher rates mean a range of personal finance products — from loans to credit cards, mortgages, savings and remittances — will be affected and borrowing will become more expensive. Here is a look at some of the effects:
For mortgage borrowers who have yet to secure a fixed rate, the news might be a concern, said Mohamad Kaswani, managing director at Mortgage Finder.
“However, this has been on the cards for a while, so it shouldn’t come as a real shock. The good news is that even with this recent increase, rates are still at historic lows and there is time to secure a fixed rate before any further hikes.”
For borrowers on fixed-rate home loans, there should be no changes to their mortgage payments until they come to the end of their fixed-rate period, Mr Kaswani said.
However, borrowers on variable rate mortgages will feel the change as soon as their next monthly payment is due, he said.
“Most banks use [the] three-month Emirates Interbank Offered Rate [Eibor], so borrowers will see the change at the end of this month. For those who would prefer more stability moving forward, they can investigate moving on to a fixed-rate mortgage.”
Three-year and five-year fixed rates currently start from 4.99 per cent and variable rates from 5.23 per cent, according to Mortgage Finder.
Interest rates on credit cards in the UAE are already high, at more than 30 per cent a year, and this type of debt is particularly susceptible to rising rates, according to Mr Valecha.
“Credit card debt already has its own high interest rate, so rate hikes from the central banks will result in consumers eventually paying more on any revolving debt,” he said.
“Now that the Central Bank of the UAE has hiked the interest rates, changes to credit card interest rates typically follow, usually within a billing cycle or two.”
Most credit cards have a variable interest rate, which means there is a direct connection to the Fed's benchmark rate, said Mohammed Shaheen, chief executive of Seven Capitals, a Dubai broker.
Borrowers with revolving debt should find a zero-interest balance transfer credit card while they can and start to pay down the balance, Mr Shaheen said.
“In other words, people can look to use this opportunity to get themselves out of a debt,” he said.
Monthly instalments on personal loans and car financing will also rise.
However, the interest rate a borrower will pay depends on a host of factors such as credit history, the type of vehicle they buy, the loan term and the down payment.
“Gradual hikes this year will lower consumers' willingness to borrow at high interest rates,” Mr Valecha said.
The historically low interest rates over the past few years have affected savings accounts. But following the UAE Central Bank's rate increase on Wednesday, consumers can expect a marginal increase that will boost their savings power.
“However, putting extra money into your savings might not result in as much interest earned from other avenues,” Mr Valecha said.
“Investors can use the higher interest rates as an incentive to boost their savings or emergency fund contributions.”
While traditional banks might be slower to pass on the rate rise to savers, consumers could look at other ways to boost their savings power, Mr Shaheen said.
“Online banks offering high-yield accounts tend to pay higher rates than traditional banks,” he said.
Watch: US Federal Reserve chief warns of 'pain' in reducing inflation
How high can interest rates go?
US inflation remains elevated at 6 per cent and is still far from the Fed's target of 2 per cent.
However, the Fed anticipates that “some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive” to return inflation to 2 per cent, chairman Jerome Powell said on Wednesday.
“The process of getting inflation back down to 2 per cent has a long way to go and is likely to be bumpy,” he said.
The Fed did not expect continuing interest rate increases but it would probably not cut interest rates this year, Mr Powell added.
When will consumers feel the pinch?
In the short term, consumers may feel the sting of higher prices more acutely than the pinch of interest rate rises, Mr Valecha said.
But as the Fed continues its rate increase programme, consumers will begin to feel the effect, he said.
“Eventually, higher rates will help cool down inflation, which will benefit consumers in the long run.”