UAE Central Bank raises interest rate as Fed stays course

The Central Bank of the UAE raised its benchmark borrowing rates after the US Federal Reserve increased its key interest rate at a more moderate level in its first policy decision of the year.

The Fed increased the policy rate by 25 basis points as it continues to push to bring inflation down towards its target range of 2 per cent and restore price stability.

This is the ninth rate increase since the US central bank started raising rates last March.

It also pushes rates in the US to their highest since the 2008 financial crisis.

The UAE Central Bank raised its base rate for the overnight deposit facility by a quarter of a percentage point to 4.9 per cent, effective from Thursday.

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, signals the general stance of the UAE regulator’s monetary policy and provides an effective interest rate floor for overnight money market rates.

Interest rates in the US are at their highest since September 2007.

A banking crisis sparked by the collapse of Silicon Valley Bank snowballed with the demise of Signature Bank and Silvergate Capital, and left First Republic Bank on the brink of collapse.

Financial stability risks complicate the Fed’s efforts to tackle inflation, as it has to stay the course with its monetary policy of tightening to cool the job market while reducing prices without exacerbating the situation — a delicate balancing act.

“The US banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring and inflation,” the Federal Open Market Committee said on Wednesday.

“The extent of these effects is uncertain. The committee remains highly attentive to inflation risks.”

While the Biden administration has said the US banking system “remains resilient and on a solid foundation”, the world’s largest economy is now expected to slide into a recession in 2023, according to Moody’s Investors Service and Goldman Sachs.

The risk of an international spillover is low due to the strong balance sheets of European lenders, ample liquidity and the limited exposure of financial institutions elsewhere, which has helped to contain the contagion from distressed US banks.

“Authorities have reacted swiftly and decisively to contain financial stress, including co-ordinated central bank action to support global liquidity,” said Stephane Monier, chief investment officer of Lombard Odier Private Bank.

“The current situation looks very different from that in early 2008, when the global financial crisis was brewing.

“Banks have bigger capital buffers, particularly the largest banks, where capital requirements were increased significantly [after the global financial crisis].

“They have less exposure to subprime mortgages and commercial real estate. Regulation has been reinforced and regulators have learnt lessons about the importance of swift and decisive action.”

The situation is more about a crisis of confidence in US lenders, rather than one involving a liquidity crunch as was the case in the 2008 financial crisis.

The Fed also said it anticipates that “some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive” to return inflation to 2 per cent.

Most central banks in the GCC follow the Fed’s policy rate moves due to their currencies being pegged to the US dollar.

Inflation in the Emirates — stoked by increasing energy prices, imported inflation and rising employment — was projected at 4.9 per cent in 2022, according to the Central Bank’s Quarterly Economic Review 2022.

That compares with a global inflation rate of 8.8 per cent, the International Monetary Fund said.

Inflation in GCC economies remained lower than the global average, benefitting from fixed exchange rates and fuel subsidies, according to the World Bank.

Global inflation is forecast to fall to 6.6 per cent in 2023 and 4.3 per cent in 2024, according to the IMF’s latest forecast.

Higher oil prices and Russia’s war in Ukraine exacerbated inflation in 2022.

A strong US dollar also increased the price of imports and food costs globally last year, but the greenback began to depreciate in September, a situation that is expected to help in easing inflationary pressures further in 2023.

Mena economies — which expanded by about 5.7 per cent in 2022, their highest in a decade, owing to a rise in energy revenue — are projected to decelerate to 3.5 per cent in 2023 and to 2.7 per cent in 2024, according to the World Bank.

GCC economies are projected to have grown 6.9 per cent in 2022, on the back of high oil prices and higher growth rates in non-oil sectors.

Growth in GCC countries is expected to slow to 3.7 per cent in 2023 and 2.4 per cent in 2024, owing to lower oil prices.

Despite last year’s global challenges, the economy of the Emirates is estimated to have grown by an annual 7.6 per cent in 2022, after expanding 3.9 per cent in 2021, the UAE Central Bank said.

The economy of the Emirates is projected to grow by 3.9 per cent in 2023, the Central Bank said.

This marks the strongest annual expansion by the Arab world’s second-largest economy since 2011, propelled by higher oil prices, a robust property sector and an increase in travel and tourism that underpinned a solid rebound from the coronavirus-induced slowdown.