US moves fuel fears of inflation

Measures to bolster American economy raise the spectre of further price rises in dollar-pegged region.

Accelerating inflation may be the most immediate impact in the Gulf from a fresh round of quantitative easing (QE) in the US.

A period of sustained US dollar weakness may be the effect of a move to pump more money into the economy, according to economists. With five of the six regional currencies pegged to the greenback, a lower dollar has a direct impact on the cost of imports.

"Inflation is a problem already in the Gulf," said Jarmo Kotilaine, the chief economist of NCB Capital in Saudi Arabia. "QE is likely to perpetuate inflationary pressures and it may even exacerbate it."

The US Federal Reserve was widely expected to announce a fresh round of bond-buying overnight as part of a plan to lower long-term interest rates and revitalise the world's biggest economy.

These purchases are expected to total about US$500 billion (Dh1.83 trillion), spread over six months. Under a government move to support US exporters, the dollar has already weakened in recent months, pushing up prices for UAE importers. "The region will be impacted if the dollar moves sharply one way or another as a result of QE," said Khatija Haque, the chief economist at Shuaa Capital. "If dollar weakness is sustained it has implications for inflation."

Inflationary pressures in the region have already been steadily increasing because of the cost of soft commodity items. Global food prices have increased about 31 per cent since the start of the year, and 15 per cent since June.

Consumer prices in the UAE reached a 16-month high of 1.2 per cent in September.

The further loosening of monetary policy is likely to limit the room for regional policymakers to control economic growth. As the US maintains low interest rates to help stimulate its economy, persisting with similar measures in the Gulf may risk stoking inflation further.

Despite this risk, regional economies could benefit from oil prices creeping up because of QE.

"As the dollar weakens, investors are likely to move their investments in commodities such as oil," said Garbis Iradian, the deputy director of the Middle East Department of the Institute of International Finance. "A stronger oil price is positive for all the economies and a cheaper dollar also benefits non-oil economies like Dubai."

American asset buying may also benefit regional financial markets.

"As happened with QE the first time, the money will go into tangible markets so it will be good for the region's equity and bond markets, as cheap funds raised in the US are likely to be invested in emerging markets offering higher returns like the GCC," said Mr Kotilaine.

The Fed embarked on its first round of QE in November 2008, when it announced a purchase of up to $600bn in assets before expanding that goal in March last year to $1.7tn of Treasury debt.