Gulf central banks join Fed in cutting interest rates

The UAE regulator reduced its base rate for the overnight deposit facility by 50 basis points

Most central banks in the Gulf region cut their benchmark interest rates on Thursday, joining the US Federal Reserve in reducing the rate for the first time in four years.

After hitting the pause on increasing interest rates since July last year, the Fed cut US interest rates by 50 basis points to the 4.75 per cent to 5 per cent range on Wednesday, at the end of its two-day Federal Open Market Committee (FOMC) meeting.

With the much-anticipated cut in the benchmark interest rates, the US has entered a monetary policy easing cycle as the Fed tries to stave off a recession and achieve a soft landing for the world’s biggest economy. The Fed kept the rates at the highest level in 23 years for more than a year to combat inflation, but the move also cooled economic growth.

“Over the past two years, the labour market has cooled from its formerly overheated state. Inflation is eased substantially,” Fed chairman Jerome Powell said on Wednesday. “This recalibration of our policies will help maintain the strength of the labour market.” It would also help further progress on inflation as the Fed begins to move towards a more neutral stance, he added.

• The Saudi Central Bank, better known as Sama, on Thursday matched the Fed rate cut, reducing its repurchase agreement (repo) rate by half a percentage point to 5.5 per cent and its reverse repo rate by a similar margin to 5 per cent.
• The UAE Central Bank reduced its base rate for the overnight deposit facility by 50 basis points to 4.90 per cent, effective from Thursday. It maintained the interest rate applicable to borrowing short-term liquidity from the regulator at 50 basis points above the base rate for all standing credit facilities, the regulator said on Wednesday. The base rate, which is anchored to the Fed's interest on reserve balances (IORB), signals the general stance of the Central Bank's monetary policy and provides an effective interest rate floor for overnight money market rates.
• The Central Bank of Bahrain cut its key rate on overnight deposits by 50 basis points point to 5.5 per cent.
• The banking regulator in Kuwait also dropped its key policy rate, the discount rate, by 25 bps to 4 per cent.
• The Central Bank of Qatar raised its repo rate by a 55 basis points to 5.45 per cent. It also reduced its deposit rate to 5.2 per cent, and the lending rate to 5.7 per cent.

Most central banks in the Gulf follow the Fed's policy rate moves due to their currencies being pegged to the US dollar, with Kuwait the only exception in the six-member economic bloc as its dinar is linked to a basket of currencies. They remained in lockstep with the Fed in its aggressive rate increase cycle despite far lower inflation in the oil-rich economies.

The Fed's bigger cut shows that it is keen to urgently tackle concerns about economic growth.

“The choice to reduce rates by 50 basis points – as opposed to a more tentative 25 bps cut – shows the FOMC are taking an aggressive approach to stimulating growth and propping up the jobs market,” said Mahmoud Alkudsi, senior market analyst at Abu Dhabi-based international securities brokerage ADSS.

“While interest rate cuts were largely priced in by markets, cuts of this extent come as somewhat of a surprise. The lower central rates will likely dampen an already sluggish US dollar in the short term.”

Oil prices, rather than monetary policy, drive spending policies of sovereigns in the region that is home to one third of the world's proven reserves. Countries including Saudi Arabia, the world's biggest oil exporter, and the UAE, the second-largest Arab economy, are undertaking tens of billions of dollars worth of projects to diversify their economies.

Most are part financed by government equity as well as commercial financing facilities and project bonds, and the lower cost will be a welcome relief.

Economic impact

The lower interest rate regime will likely spur economic momentum in the Gulf economies that have maintained strong growth since the pandemic despite global headwinds and geopolitical turmoil, analysts said.

Emirates NBD, the biggest bank in Dubai, said it is “leaving its growth targets unchanged” at this time, given the anticipated benefits for the Gulf region in the wake of the monetary easing-driven assistance to regional economies.

The UAE economy, which has maintained a strong growth streak since 2022, grew by 3.4 per cent in the first quarter of this year. The country’s real gross domestic product reached Dh430 billion ($117 billion) during the January to March period, the Ministry of Economy said earlier this month, citing preliminary estimates from the Federal Competitiveness and Statistics Centre.

A 4 per cent year-on-year rise during the quarter in the non-oil sector of the Arab world's second-largest economy drove growth as the Emirates continued its economic diversification strategy.

Business activity in the UAE's non-oil private sector also maintained growth momentum in August. The seasonally adjusted S&P Global purchasing managers’ index reading increased to 54.2 in August, from 53.7 in July, well above the neutral 50 mark that separates economic growth from contraction.

The UAE's economy rose by 3.6 per cent last year, driven by a 6.2 per cent boost from the non-oil sector. It is projected to grow by 3.9 per cent this year and accelerate to 6.2 per cent expansion next year, with oil production forecast to increase significantly as Opec eases cuts, while the non-oil sector continues to grow, the Central Bank said.

“With the interest rates down, we might see an increase in credit growth, which will be positive for banks and rate sensitive sectors,” Faisal Hasan, chief investment officer and head of asset management at Al Mal Capital, said. “Also, from the investment point of view, dividend yielding asset will catch investor attention.”

The inflation dynamic

The UAE Central Bank projects inflation in the country to rise to 2.3 per cent, compared to 1.6 per cent last year, due to a moderate increase in commodity prices, wages and rents. It also expects consumer prices to average a 2.3 per cent rise next year.

Inflation in Saudi Arabia has also remained relatively low over the past two years. Annual inflation is projected to fall to 1.9 per cent by the end of this year, compared with 2.3 per cent last year, S&P Global Ratings said earlier this month.

“Lower interest rates will be a tailwind to non-oil economies across the region where many have a much lower inflation profile than the US,” Edward Bell, head of market economics at Emirates NBD, said.

Global inflation is forecast to decline steadily, to 5.9 per cent in 2024 and 4.5 per cent in 2025, after hitting 6.8 per cent last year, according to estimates by the International Monetary Fund.

Inflation in the US has come down to 2.4 per cent in August, close to the 2 per cent desired level of the Fed, which had started the rates increase cycle in March 2022 to combat prices that hit a four-decade high of 9.1 per cent in June 2022.

The high interest rate environment aimed at cooling both inflation and job growth has stoked fears of a recession. JP Morgan Chase, the biggest US lender, in August, raised the probability of a US and global recession materialising before end-2024 to 35 per cent. It kept the probability of a recession happening by the end of next year unchanged at 45 per cent.