The UAE Central Bank, which follows US monetary policy as the dirham is pegged to the US dollar, is likely to keep its interest rate unchanged at 1.5 per cent for the rest of the year as inflation remains tepid, analysts at BMI Research said.
The analysts believe the Central Bank will maintain a slight premium to the US Fed fund rate, which stands at between 1 per cent and 1.25 per cent, through to at least 2021. In line with forecasts of US Federal Reserve hikes over the next two years, BMI said that the UAE was likely to boost interest rates by 100 basis points in 2018 and 2019.
"Inflation in the UAE has remained steady despite subsidy cuts, removing any inclination to hike and the peg of the Emirati dirham to the US dollar will mean that the Central Bank of the UAE will seek to maintain the interest rate deferential, even as growth remains lacklustre," BMI Research said.
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The UAE economy has been treading water in the past couple of years, weighed down by a drop in consumer confidence and business expansion. The economy grew 3 per cent in 2016, slowing from 3.8 per cent the previous year, following a lull in non-oil economic growth, according to the Federal Competitiveness and Statistics Authority. Many economists expect growth this year will be muted with many, including the Egyptian investment bank EFG-Hermes, forecasting that GDP will not rise by much more than 1 per cent before rebounding next year.
The UAE Central Bank last raised rates in March when it increased the interest on its certificates of deposit, its main monetary policy transmission tool, by 25 basis points.
That comes at a time when the fortunes of the US and the UAE economy are taking divergent paths. While the US economy is recovering from the financial crisis of 2008, allowing the Fed to start raising rates, the UAE economy has slowed down since 2014 when the price of oil crashed. If oil prices remain low and interest rates rise, that could add increased pressure to the local economy, economists say.
To counter the drop in revenues from oil, regional governments are introducing new forms of taxation, reducing subsidies and selling off stakes in government companies to help to bolster budgets. Last week, the UAE's introduction of a 5 per cent value added tax that will start in January 2018 was approved and it is likely to have an inflationary impact on the economy.
"There are a host of exemptions to this for essentials such as food items but given the importance of the retail sector in the UAE it will drive up price growth once implemented," the BMI report said. "That said, hiking rates in line with the US will help contain these pressures, and we forecast that inflation will average 2.8 per cent next year."
