Fed Hike Leads Gulf to Follow, But Rate Paths Diverge Again

(Bloomberg) -- Most central banks across the Arab Gulf followed the Federal Reserve in raising interest rates for the fourth time this year to maintain their currencies’ pegs to the US dollar, although Kuwait and Qatar didn’t match the increase in full.

A mismatch between the US, where inflation is running at the hottest pace in four decades, and the economies of the six members of the Gulf Cooperation Council has created additional room for maneuver for local policy makers who don’t need to act with the same urgency to contain price pressures. 

But with most regional currencies tethered to the dollar, central banks still largely track Fed decisions. On Wednesday, Saudi Arabia, Bahrain and the United Arab Emirates moved in lockstep with the US central bank and raised their benchmarks by 75 basis points.

By contrast, Kuwait, which maintains a peg to a basket of currencies, didn’t deliver the full rate hike and increased its discount rate by 25 basis points only, while Qatar increased its lending rate by 50 basis points. In June, the misalignment with the US already allowed Saudi Arabia and Kuwait to lift rates by less than the Fed’s 75 basis-point move. 

“Some GCC counties still have flexibility not to fully follow the magnitude of the Fed’s rate hike,” Monica Malik, chief economist at Abu Dhabi Commercial Bank PJSC, said before the rate announcements. “The critical point is that inflation levels in the GCC are significantly below the US levels, especially for the countries that have introduced fuel price caps. Thus, the region does to require the same degree of monetary tightening as in the US.”

• Kuwait raised its discount rate by 25 basis points to 2.5% from 2.25%
• Qatar raised its deposit and repurchase rates 75 basis points to 3% and 3.25% respectively, while increasing its lending rate 50 basis points to 3.75%
• Bahrain raised its overnight deposit rate 75 basis points to 3%, its four-week deposit rate to 4%, its lending rate to 4.5% and its one-week deposit facility to 3.25%
• The UAE raised its overnight deposit facility by 75 basis points
• Saudi Arabia increased its repo rate 75 basis points to 3% and its reverse repo rate 75 basis points to 2.5%

In the US, Fed Chair Jerome Powell is moving aggressively to raise rates amid criticism he was slow to respond to rising prices last year.

But the oil-rich Gulf is among regions where inflation has remained relatively muted, thanks in part to limits on domestic fuel costs in some countries and price controls on food in the case of Kuwait. Consumer inflation across the GCC is set to end the year at 3.1%, according to the International Monetary Fund, much lower than in the US and across the wider Middle East.

Tighter liquidity conditions for Saudi banks has been an additional factor behind the kingdom’s slower pace of monetary tightening. The Saudi central bank placed funds as time deposits with commercial lenders in June to ease the cost of money, Bloomberg News has reported.

“The question is how do Gulf countries manage tighter monetary policy that is being imposed on them?” Scott Livermore, chief economist at Oxford Economics Middle East, said before the rate decision. “This is likely to consist of measures like liquidity injections in Saudi Arabia that may help limit the rise of interest rates charged by banks and the fiscal policy-monetary policy mix with governments becoming even more supportive of growth.” 

Read: Saudi Arabia Injects $13 Billion in Liquidity-Starved Banks

With oil prices set to average above $100 a barrel this year, most countries in the region are on track to run large budget surpluses, according to the IMF, giving them more scope to increase spending. 

Although less pronounced than in other parts of the world, inflation is also on the rise in the Gulf after commodity prices soared following Russia’s invasion of Ukraine earlier this year. 

Input costs in the UAE and Saudi Arabia have surged over the past few months, according to Purchasing Managers’ Index surveys compiled by S&P Global, though companies didn’t always pass on higher costs to consumers. Still, inflation in Dubai, part of the UAE federation, spiked near an annual 6% in June, the highest on record. 

To help people cope with rising costs, both Saudi Arabia and the UAE set aside about $13 billion to support low-income citizens and stockpile key commodities. Gasoline prices are especially a concern in the UAE, where they have outpaced increases in neighboring countries. 

The region was hit hard by the pandemic in 2020 as Covid-19 lockdowns and disruptions to trade and tourism coincided with a slump in crude oil, their main source of income. Governments responded with massive fiscal stimulus packages while central banks followed the Fed in cutting rates to near zero. 

“We do not expect tighter monetary conditions to negatively impact GCC non-oil sector growth,” said Carla Slim, Dubai-based economist at Standard Chartered Plc. “Although we do envisage a slowdown in weighted GCC growth to 4.5% in 2023 from 7.7% in 2022, as oil production nears full capacity.” 

(Updates with Saudi Arabia’s rate decision in fifth bullet point.)

More stories like this are available on bloomberg.com

©2022 Bloomberg L.P.