Since the US cut interest rates last week, the Central Bank has remained tight-lipped over whether it will follow suit, which economists say could mean it intends to break with recent tradition and hold the rate steady. This would mark a significant departure from an implicit policy of matching Fed rate cuts, a pattern it has followed since last December, according to EFG Hermes. Gulf countries that peg their currencies to the dollar - including the UAE - must keep their rates in line with US rates or risk creating a potentially destabilising flow of speculative investments, economists said. The Central Bank's benchmark overnight repurchase rate stands at 1.5 per cent. Following the US announcement, Kuwait, Bahrain, Saudi Arabia and Iraq all cut rates within 24 hours. In the absence of an official statement from the Central Bank, economists offered varying explanations for the unexpected lack of movement. Mohammed Jaber, an economist at Morgan Stanley, said a decision to hold rates steady could have some benefits, although not without a cost. Not cutting rates could help ward off inflation, which the International Monetary Fund said was expected to reach 12.9 per cent in the UAE this year, but could also put borrowers under pressure at a time when economists say more, not less, credit is needed to relieve a cash liquidity squeeze. "The main macroeconomic concern at this juncture is the provision of sufficient liquidity to the banking system," said Mr Jabar, calling any decision not to cut rates "untimely". The benchmark overnight repurchase rate determines the price the government charges banks for short-term loans, so lowering it normally has the effect of increasing the amount of credit in the economy and lowering interbank rates. However, the three-month Emirates interbank offer rate (Eibor) has more than doubled since June and refuses to budge despite Government offers to inject more than Dh120 billion (US$32.6bn) into the local financial system. On Thursday, the three-month Eibor rate stood at 4.79 per cent. Tristan Cooper, an analyst at Moody's, said the government may be trying to keep rates high to attract foreign depositors. Such an inflow of funds could help replace the large amount of money that suddenly left the country this summer as investors anticipated a de-pegging of the dirham to the dollar. In the past, foreign depositors were willing to accept a lower interest rate on their dirham deposits because they expected the currency to appreciate. Now that the Government has made clear it will maintain its dollar peg, UAE banks will have to raise their interest rates to become attractive again to overseas depositors. "A wider interest rate differential with the US dollar will help banks to attract dirham deposits. Deposit outflows have hit banks' funding profiles over the past several months," he said. According to Mr Jaber, the Central Bank could also be concerned that reducing its benchmark overnight repurchase rate might inject too much credit into the system. The first Dh50bn of the Dh120bn injection is linked to the Central Bank's benchmark rate. By lowering the interest rate, the Central Bank would make that money more attractive, which could rapidly increase the amount of money in the system. tpantin@thenational.ae
