What the Fed rate hike means for GCC

The third rate increase by the US Federal Reserve in six months by a quarter point to 1.0-1.25 per cent on Wednesday will have repercussion across most GCC states as the consequent escalation in bank finance rates will likely stoke up cost of living and doing business.

Immediately after the US hike, the UAE Central Bank said it was raising its key interest rate by 25 basis points. Central banks in Saudi Arabia, Kuwait, Qatar and Bahrain also followed suit by hiking rates by 25 basis points.

The repo rate for borrowing short-term liquidity from the UAE Central Bank against certificates of deposit has been increased by 25 bps to 1.50 per cent.

Certificates of Deposit, which CBUAE issues to banks operating in the country, are the monetary policy instrument through which changes in interest rates are transmitted to the UAE banking system.

In explaining this second rate hike of 2017 and plans for more increases in the coming months, Federal Reserve Chair Janet Yellen said the move reflected the progress in the world's largest economy, which continues to add jobs at a solid pace."The economy is doing well, is showing resilience," Yellen said in her quarterly press conference.

Economists warned that in the UAE and other Gulf economies, the rise in interest rates will pose further headwinds to the already slow economic growth. The monetary tightening in the wake of interest rate hike will have counter-productive impact in the GCC economies by compounding fiscal tightening unlike in the US where the economy is on an upswing, economists said.

For GCC governments and large corporates, such rate hikes will increase the cost of raising debt from bond market at a time of lower oil prices.

However, the good news for the UAE expats who regularly transfer money to home countries is that a stronger dollar-pegged dirham will result in better exchange rates. But for investors from overseas, property purchases will become more expensive and less attractive.

And for resident investors too, higher finance rate will make properties more expensive with the higher cost of bank funding for projects resulting in a corresponding price increase from the side of developers in addition to rising mortgage rates. For those planning buy a car, a half percentage rise in interest, will have much impact. In other words, residents will have to pay more interest if they borrow while savers among them are going to earn more interest.

Another sector likely to be directly impacted is the tourism sector as travellers from countries of weaker currency will have to pay more of their currency to travel to the Gulf. Rising borrowing costs can also hurt the SME sector that depends on banks or external funding for their business operations

GCC residents will also have to pay higher rates of interest on his personal loan, auto loan, and credit card transactions. Most credit cards on the market have a variable rate, which means there's a direct connection to the benchmark rate.

However, with the dirham becoming stronger, in the UAE prices of imported goods, including gold, mobile phones, electronics and home appliances are poised to slightly come down.

Analysts said if the US Fed hikes rates one more time this year, as is widely expected in December 2017, borrowing cost for a normal bank customers will go up by 100 bps or one per cent. Which means, for a Dh100,000 bank loan, the borrower will have to pay Dh1,000 more annually. After the previous hike on March 15, US Fed officials indicated two more rate hikes - in June and December.

As higher rates may reduce borrowing and spending, sectors such as restaurants and shopping malls that depend heavily on consumer discretionary spending may suffer. Higher rates may also force companies to slow down their hiring plans, analysts said.

Gulf Arab countries are struggling to bolster economic growth as oil prices fall and a strong dollar hurts industries such as tourism. Countries that have a wide interest-rate gap with the Fed "will look to keep benchmark lending rates on hold," said Monica Malik, chief economist at Abu Dhabi Commercial Bank.

Analysts at Capital Economics said the Fed's decision to raise interest rates again does not change the big picture that global monetary policy will remain highly accommodative. "We expect policy rates to stay close to zero in the euro-zone and Japan for the next two years, and "global QE" to continue until late 2018." Fed officials still expect to announce one more rate hike this year and three more in 2018. They also outlined plans to reduce their asset holdings only gradually, starting with $10 billion per month and rising to $50 billion. But in the rest of the world, monetary policy will remain exceptionally loose.

Emilio Pera, Partner and Head of Financial Services at KPMG Lower Gulf, said the continued strength in the US job market with unemployment at 16-year lows warranted the case for a rate increase. "While inflation is still eluding the preferred annual mark of 2 per cent, it is premature to say that it would weaken the momentum of the Fed's interest rate actions. The longer the Fed prolongs the decisions, the longer it would take for it to normalise the Federal Funds Rate and lower its inflated balance sheet. All eyes are now on the Trump administration to deliver policies that could stoke inflation, and give the Fed headroom to meet its interest rate targets through 2018," said, Pera.

Source: Khaleej Times