Gulf central banks raise interest rates after Fed doubles down to tame inflation

The central banks of the UAE, Saudi Arabia, Bahrain, Kuwait and Qatar raised their benchmark borrowing rates after the US Federal Reserve doubled down and aggressively raised its key interest rate to tame surging inflation and restore price stability.

The Fed on Wednesday increased the policy rate by 75 basis points (bps) after a larger-than-expected three-quarters percentage point in June. This is the Fed's fourth interest rate increase in four months and the biggest since 1994.

The move to stem rising consumer prices comes as global financial markets wobble amid rising energy prices and high inflation. Most central banks in the GCC follow policy rate moves by the Fed due to the peg of their currencies to the US dollar. Kuwait is an exception in the six-member economic bloc as its dinar is linked to a basket of currencies.

In line with its "objective of maintaining monetary and financial stability, and in light of recent global developments", the Saudi Central Bank, better known as Sama, raised its repurchase agreement (repo) rate by three-quarters of a percentage point to 3.00 percent and its reverse repo rate by a similar margin to 2.50 per cent.

Annual inflation in the kingdom, the Arab world's largest economy, edged higher to 2.3 per cent in June of 2022 from 2.2 per cent in May. Saudi Arabia's inflation rate for 2022 is forecast to reach 2.4 per cent this year, driven by a global rise in food prices triggered by the Russia-Ukraine war, according to Jadwa Investment.

The Central Bank of the UAE raised its benchmark base rate for its overnight deposit facility (ODF) by three-quarters of a percentage point. It maintained the rate applicable to borrowing short-term liquidity from the regulator through all standing credit facilities at 50 bps above the base rate, 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 CBUAE’s monetary policy and provides an effective interest rate floor for overnight money market rates. Inflation in the UAE, the second-largest economy in the Arab world, is relatively low compared with rates in other parts of the world. The consumer price index (CPI) increased by 3.4 per cent during the first quarter of 2022, compared with 0.6 per cent and 2.3 per cent in the third and fourth quarters of 2021, respectively.

Inflation in the Emirates is projected to reach 5.6 per cent in 2022, according to the latest data from the CBUAE. For 2022, inflation globally has been forecast at 8.3 per cent, averaging 6.6 per cent in advanced economies and 9.5 per cent in emerging market and developing economies, the International Monetary Fund said.

The Central Bank of Kuwait (CBK) also increased its discount rate by 0.25 bps to 2.50 per cent. The CBK said it also changed the rates of monetary policy instruments by varying percentages for the entire interest rate yield curve, including repurchases, CBK bonds and tawarruq, term deposits, direct intervention instruments, as well as public debt instruments

"This decision came in light of recent development in the local and international economic and geopolitical developments that affected the global inflation rates and, hence, the consumer price index in the State of Kuwait," said governor Basel A. Al-Haroon.

The Central Bank of Bahrain (CBB) increased its key rate on one-week deposits by 75 basis points to 3.25 per cent “to ensure the smooth functioning of the money markets” in the kingdom.

The interest rate on overnight deposits was also raised by three quarters of a percentage point to 3.00 per cent, and the interest rate on four-week deposits by 75 bps to 4.00 per cent, the CBB said.

The Bahraini regulator also raised the interest rate applicable to its lending facilities to retail banks in the kingdom by three quarters of a percentage point to 4.50 per cent.

The Central Bank of Qatar also increased raised its repo rate by 75 bps to 3.25 per cent. It also raised its deposit rate by three quarters of a percentage point to 3.00 per cent and the lending rate by 50 bps to 3.75 per cent.

In March, the Fed raised rates by a quarter percentage point for the first time since December 2018, after keeping them near zero to soften the impact of Covid-19 on the economy. The Fed, which was criticised for initially viewing inflation as transitory, was forced last month to raise its policy rate by a larger-than-expected three-quarters of a percentage point due to rising consumer prices. That rate increase was its third interest rate increase in three months and the biggest since 1994 and signalled that more rate increases are coming.

Inflation in the US hit 9.1 per cent in June, the highest level since 1981. The US central bank aims to bring it down towards its target range of 2 per cent as Americans grapple with higher prices. The consumer price index rose 1.3 per cent from a month earlier, exceeding all estimates, with shelter, food and petrol remaining the biggest contributors to overall price increases.

Surging oil and gas prices, exacerbated by Russia’s war in Ukraine, have fed into already rising inflation. Brent, the benchmark for more than two-thirds of the world crude, rose to a notch under $140 a barrel in March. It has given up some gains, but still trades above $100 a barrel.

The impact of higher energy prices and shrinking consumer spending power on economic growth has also hit US stocks, plunging markets into bear territory.

The Russia-Ukraine conflict has exacerbated the slowdown from the Covid-19 pandemic, upending commodity markets and disrupting global trade. This will keep food and energy prices at “historically high levels” until 2024, the World Bank said in May.

In June, the World Bank slashed its growth forecast for the global economy for the second time this year as a result of the Ukraine war. It lowered its estimate for 2022 to 2.9 per cent, from a 3.2 per cent projection it issued in April and a 4.1 per cent estimate made in January.

The Institute of International Finance lowered its estimate for the global economy to 2.3 per cent and on Tuesday the IMF cut its growth forecast for the second time this year to 3.2 per cent in 2022.

Fed officials want to further raise rates without harming a tight labour market. The Federal Open Market Committee said on Wednesday that it decided to raise the target range for the federal policy rate to between 2.25 per cent and 2.5 per cent, adding it “anticipates that ongoing increases in the target range will be appropriate".

However, economists fear that aggressive rate increases intended to stem inflation will run the risk of pulling the economy into recession. "This action was very largely priced into the market. As a result ... the stock market is holding on to its gains," said Naeem Aslam, chief market analyst at Ava Trade.

"Going forward, the Fed needs to make sure that they continue to address all the noise about the future interest rate hike as it is highly likely that the next interest rate (rise) will not be 75 basis points."

The market expects 200 bps of interest rate increases by the end of the third quarter of this year. "The Fed must walk a fine line as any validation of that will undermine its efforts to tighten and get a grip on inflation," said Craig Erlam, a senior market analyst at Oanda. "Attention will be on its guidance over the coming months and how hawkish it will continue to be."

Fitch Ratings expects the Fed to raise interest rates to 3 per cent by the fourth quarter of this year and to 3.5 per cent by the first quarter of 2023. This is above the US central bank's estimates of the neutral rate.

"The inflation picture in the US is still resolutely bad ... we expect the Fed is going to continue to fight against inflation to carve it out of its entrenched position as a drag on the US economy," said Edward Bell, senior director of market economics at Emirates NBD.

"While they may be able to weaken the domestic drivers of inflation — demand for services, higher wages for example — the Fed has little control over the external factors causing high inflation in the form of oil prices or supply chain disruptions. An overly hawkish Fed now may help to bring inflation closer to target levels, even if the pain felt across the US, and indeed global economy, is acute."