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Abu Dhabi, UAEWednesday 24 October 2018

UAE raises benchmark rate by 25 basis points following Fed increase 

The US central bank on Wednesday raised its target range for the federal funds interest rate by a quarter point

The Central Bank of UAE has increased the key interest rate following the US Federal Reserve's decision to raise its interest rate. Sammy Dallal / The National
The Central Bank of UAE has increased the key interest rate following the US Federal Reserve's decision to raise its interest rate. Sammy Dallal / The National

The Central Bank of the UAE raised its benchmark interest rates by 25 basis points following a rate hike by the US Federal Reserve, which indicated further moves are likely this year and next.

The UAE's banking regulator pushed the interest rate higher by 25 bps on its certificate of deposits, that are used as a monetary policy instrument through which changes in interest rates are transmitted to the financial institutions, the central bank said on Wednesday. The rate rise is effective from Thursday, which is also when the repo rate on borrowing short-term liquidity from the central bank against certificates of deposits goes up by 25 bps.

Saudi Arabia's central bank said it was raising its reverse repo rate by 25 bps to 2.25 per cent, and its repo rate by the same margin to 2.75 per cent. Bahrain's central bank raised its interest rate on its one-week deposit facility to 2.5 per cent from 2.25 per cent. Kuwait said it is keeping its key discount rate unchanged at 3 per cent. Unlike other GCC states which peg their currency to the greenback, Kuwait links its dinar to a basket of currencies.

The Fed on Wednesday increased its target range for the federal funds interest rate by a quarter point, to between 2 per cent and 2.25 per cent. The move reflects the continued strength of the economy as growth and job numbers remain strong and inflation remains near the Fed’s 2 per cent target rate. The unemployment rate in the US reached 3.9 per cent in August, an 18-year low, while annual inflation reached 2.7 per cent in the same month.

Arabian Gulf central banks don’t always raise or cut rates on each specific occasion when the Fed does, but they broadly follow it over the long run.

This is the Fed's third rate rise this year and the eighth increase since 2015. The central bank rate is now at the highest level since October 2008, just after the collapse of Lehman Brothers.

US president Donald Trump who opposes higher interest rates was quick to attack the Fed.

"I am not happy about that," he said at a press conference in New York. "I'd rather pay down debt or do other things, create more jobs, so I'm worried about the fact that they seem to like raising interest rates. We can do other things with the money. But they raised them."

Mr Trump's position was markedly different when he was a presidential candidate, attacking then Fed Governor Janet Yellen and the US central bank for keeping interest rates low after the 2008 financial crisis and contributing to what he said was a "big, fat, juicy bubble".

The Fed is increasing rates, ignoring the escalating trade war among the world’s two biggest economies, which is threatening to derail the growth outlook of the global economy. After the US administration said it was slapping tariffs on $250 billion worth of Chinese goods, Beijing retaliated this week and said there is little hope of restarting trade talks with Washington.

The International Monetary Fund, the World Bank and the World Trade Organisation, however, have all urged both United States and China to exercise restraint in their tit-for-tat rounds of tariffs.

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Read more:

UAE Central Bank follows Fed and raises key interest rate by 25 basis points

Most GCC Central banks likely to mimic Fed as it prepares to raise interest rates

Fed lifts rates, steepens path through 2020 for more hikes

UAE Central Bank raises interest rates by 25 basis points

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David Kohl, the chief currency economist at Julius Baer said the bank in the coming year expects Fed to continue raising rates, despite the escalation in trade conflict. The Fed will do it as long as the growth impact is rather muted while the inflationary effects become more apparent in the US economy.

The Bank of Singapore estimates another rise by the US central bank in December, three more in 2019 and one in 2020 which "would leave policy in slightly restrictive territory," with interest rates at 3.4 per cent by 2020 compared to a neutral rate of 3 per cent.

Being a net importer of most goods and services with the exception of hydrocarbons, the Gulf region, which is home to about a third of the world’s proven oil reserves, is not severely impacted by the trade war. However, the Fed rate hikes will be consequential for the region's energy dependent economies. In the wake of an oil slump that began in 2014 and lower borrowing rates GCC sovereigns turned to capital markets to raise funds to meet their spending needs.

Crude prices, which fell below $30 a barrel in the first quarter of 2016, have risen significantly and breached $80 per barrel mark this month, reducing funding needs of GCC states. However, governments will still need to tap debt markets in order to fuel their economies.

But the rising cost of borrowing for the Gulf issuers is expected to dent investor appetite for GCC credit as liquidity tightens, said Mohammed Damak, senior director and global head of Islamic finance at S&P.

Oil price stabilisation has brought some fiscal stability in the region which has about $350bn worth of funding requirements at the government level between 2018 and 2021. These financing requirements could be met either by drawing down on assets or issuing debt at the sovereign level, Benjamin Young, associate director and sovereign and international public financing ratings at S&P said.

The rising cost of borrowing and tightening liquidity will make it more challenging for some countries, who don't have the fiscal buffers enjoyed by some of their regional peers, to bridge their budget gaps.

The effect of rising interest rates will also be felt by the corporate and financial institutions which have turned to capital markets in the past few years to raise funds. However, Abdulfattah Sharaf, the group general manager and chief executive of HSBC in the UAE expects debt issuance - sukuk, bonds and export credit agency-backed deals – at least in the UAE, to remain stable even with the Fed rate hikes.