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|21 December, 2018

Cost of borrowing increases in UAE as central bank hikes interest rates

The UAE central bank said its repo rate for borrowing short-term liquidity had been increased by 25 bps.

Image used for illustrative purpose. Vehicles stop at a red light in front of the main branch of UAE Central Bank in Abu Dhabi, January 29, 2013.

Image used for illustrative purpose. Vehicles stop at a red light in front of the main branch of UAE Central Bank in Abu Dhabi, January 29, 2013.

REUTERS/Ben Job

UAE - The cost of borrowing in the UAE and GCC increased on Thursday after regional central banks hiked interest rates in line with the US Federal Reserve.

Following the Fed's decision to increase the Federal Funds Rate by 25 basis points at its meeting late on Wednesday, the Central Bank of the UAE also increased interest rates applied to the issuance of its certificate of deposits in line with the increase in interest rates on the US dollar, the apex bank said late on Wednesday.

Certificates of deposit, which the UAE central bank issues to banks operating in the country, are the monetary policy instrument through which changes in interest rates are transmitted to the UAE banking system.

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It was the fourth rate hike this year by the Fed, taking its overnight lending rate to a range of 2.25 to 2.50 per cent.

Apart from Kuwait, other central banks in the GCC also made similar moves.

Economists expect that there would be only two more rate hikes in 2019 compared to the three projected earlier because the message sent by Fed chairman Jerome Powell was clear that the US economy continues to perform well and no longer needs the Fed's support either through lower-than-normal interest rates or by maintaining a massive balance sheet.

Timothy Fox, head of research and chief economist at Emirates NBD Research, said in note on Thursday that the Fed cut its growth and inflation forecasts and lowered the dot plot to imply two increases in 2019 instead of three.

"The new median projection puts the Fed funds rate at 2.9 per cent by the end of 2019 and 3.1 per cent by the end of 2020, down from 3.1 per cent and 3.4 per cent [respectively] in September projections," he said.

Anita Yadav, head of fixed income research at Emirates NBD Research, said most floating rate loans use the three-month Emirates Interbank Offered Rates (Eibor) as their base rate, which may or may not increase to the same magnitude as the policy rates.

"In a rising interest rate environment, it would be logical to explore the options of fixing the interest rates and or change the type and tenures of loans in order to minimise the interest expense," she said.

Regionally, the Central Bank of Bahrain also raised its key policy interest rate on the one-week deposit facility from 2.50 per cent to 2.75 per cent.

It also decided to increase the overnight deposit rate from 2.25 per cent to 2.50 per cent and the lending rate from 4.25 per cent to 4.50 per cent, while the one-month deposit rate will remain the same at 3.25 per cent. Saudi Arabia's central bank said it was raising policy rates to preserve monetary stability. It increased its repo rate to 3 per cent from 2.75 per cent, and the reverse repo rate to 2.5 per cent from 2.25 per cent.

Meanwhile, Kuwait's central bank said that it had decided to maintain its discount rate unchanged at its current level of 3 per cent. On the impact of interest rates on gold and commodities, Hussein Sayed, chief market strategist at FXTM, said the interest rate hike has minimal impact on asset prices, including energy markets, since it was widely anticipated.

Powell was optimistic about future growth, and believes that the US economy remains on strong footing.

"However, markets are not convinced about his economic assessment," Sayed said.

"Investors appear to be pessimistic about future growth and this is evident in the bonds markets and 10-2 year spread falling below 10 basis points on Thursday. If bonds markets are correct in predicting an economic slowdown, and the Fed continues to tighten policy albeit at a slower pace, these two factors will be negative for oil prices, which may require further cuts in production from Opec+ to keep the markets in balance."

Gold prices, he noted, seemed to be benefiting from two factors: expectations of slowing down interest rates hikes in 2019 and the extreme volatility in equity markets.

"However, the hike in interest rates on Wednesday and the more hawkish tone from Powell led to some profit-taking after recent gains. Going forward we see a combination of factors that will move gold including yields on treasury bonds, equity markets volatility, and most importantly the dollar's direction. Overall, expect the risk to remain to the upside in 2018," he noted.

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