Rate hike and future guidance point to higher cost of funds in GCC

Thursday, Jun 15, 2017

Dubai

The Central Bank of UAE late on Wednesday raised in its key interest rate by 25 basis points, following the US Federal Reserve’s decision to hike rates by the same margin.

The apex bank has effected the rate increase by hiking its repo rate or the rate at which it provides short-term liquidity to banks against certificates of deposits. With the latest increase, the repo rate has been increased to 1.50 per cent.

Analysts said the latest round of rate hike and the guidance indicating up to 3 to 4 more hikes in the next 12 months, cost of funds across GCC countries are expected to go up.

The 25 bps rate hike by the Fed this week is certain to push up GCC market rates, though GCC central banks have tended to respond differently following US rate hikes in the past.

Like in the past Saudi Arabia’s central bank has left its repo rate unchanged at 2 per cent while raising its reverse repo rate, the rate at which commercial banks deposit money with the central bank, by 25 basis points to 1.25 per cent.

Kuwait refrained from following the US Federal Reserve’s interest rate increase for the first time since 2015, citing modest economic growth in the country hit by lower oil prices. The central bank left the discount rate at 2.75 per cent, according to a statement.

“The decision reflected the limited economic growth and the continued increase of interest rate on the US dollar and all the challenges that entails,” Kuwait central bank Governor Mohammad Yousuf Al Hashel said in a statement.

Bahrain’s central bank said on Wednesday it was raising key interest rates by 25 basis points after the US Federal Reserve hiked rates. The key policy interest rate on Bahrain’s one-week deposit facility was increased to 1.50 per cent from 1.25 per cent.

More hikes

Fed’s median interest rate projections were left broadly unchanged at 1.4 per cent for end-2017 and 2.1 per cent for end-2018, implying one more rate hike this year and an additional three next year.

The economic assessment was generally upbeat, although there was acknowledgement of an easing back in inflation, but this is expected to move back to the 2 per cent target over the medium term.

“While inflation is still eluding the preferred annual mark of 2 per cent, it is premature to say that it would weaken the momentum of the Fed’s interest rate actions. The longer the Fed prolongs the decisions, the longer it would take for it to normalise the Federal Funds Rate and lower its inflated balance sheet,” said, Emilio Pera, Partner and Head of Financial Services at KPMG Lower Gulf”.

Analysts say with the Fed hinting at another hike this year and likely 2 to 3 hikes next year, regional central banks’ headroom for keeping diverging rates with Fed rates are limited in the context of pegs GCC currencies to the dollar.

“The Central Bank of the UAE has already matched the US rate hike saying that it has raised the repo rate by 25 bps to 1.5 per cent, with other regional central banks likely to follow suit consistent with the operation of the currency pegs,” Emirates NBD said in a note.

Monetary tightening in 2017 will continue to act as a headwind to any pickup in economic activity in the GCC this year. The US rate hiking cycle will also underpin dollar strength, which will continue to erode the export competitiveness of the GCC’s non-oil sector.

Faltering recovery in oil price despite recent output cuts are expected to add further budgetary constraints to GCC governments as the external borrowing cost are set to rise. Additionally, the increase in funding costs are likely to make its way to corporates and consumers via higher interbank rates affecting both investment and consumer demand.

Analysts say domestic liquidity conditions and the spread of interbank rates over Libor will be largely determined by the oil price and the extent of the recovery in oil export receipts. If the recovery in oil prices can’t be sustained a steeper US tightening cycle will amplify liquidity pressures.

Higher rates are expected to have an adverse impact on the borrowing costs of regional sovereigns and corporates. Faced with fiscal deficits, a number of GCC sovereigns have been tapping the global debt markets. Higher Fed rates could effectively increase their funding costs.

Babu Das Augustine, Banking Editor

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