Investors betting on an appreciation of the dollar-pegged United Arab Emirates dirham pushed the currency to a six-week high on Monday after Gulf central bankers failed to revive a monetary union plan.
Bids on the dirham firmed to 3.6718 per dollar in early trading, the highest level since July 26, the day after Kuwait allowed the dinar to appreciate to an 18-year high against the sliding US dollar.
Kuwait dropped its peg to the dollar in May saying the dollar's slide on global markets was making imports more expensive and fuelling inflation. The dollar hit a 15-year low against an index of six major currencies on Monday.
A possible US interest rate cut this month will test the UAE's commitment to a currency peg put in place to prepare for monetary union by 2010, a deadline central bank governors said after a meeting on Saturday would be difficult to meet.
Should the US Federal Reserve cut rates on September 18 as markets expect, the UAE would be under pressure to follow to maintain the relative value of its currency, and ignore rising inflation, which hit a 19-year high of 9.3% last year.
"With inflation rates rising across the region there is increasing pressure for a policy response," Deutsche Bank regional economist Caroline Grady said in a note on Monday.
The dirham eased to 3.6726 per dollar at 1045 GMT, partly because traders were not betting on a quick revaluation.
"People aren't expecting it to happen in the short term, but the pressure is there," said a treasury manager at Emirates Bank International Ltd, who asked not to be named.
Governors of the six Gulf Arab states would develop separate policies to tackle rising inflation, Saudi Arabia's central bank governor said after Saturday's meeting.
Saudi Arabia, the UAE, Kuwait and three neighbours had agreed an inflation target of no more than 2% above the regional average as part of plans to create a single currency.
With central banks free to chart their own course on monetary policy, economists said changes to the dollar-pegged exchange rate regime were increasingly likely.
"Such comments raise the likelihood of further fx moves across the Gulf with the dirham continuing to be our top pick for the next move," Grady said.
Deutsche Bank said last week the UAE would allow the dirham to appreciate against the dollar this year.
Monica Malik, chief economist at Cairo-based EFG-Hermes, said such a move probably wouldn't happen this year.
"Gulf countries will not jeopardise currency stability and any currency reform would involve a move to a currency basket like Kuwait, which would allow greater monetary flexibility and the ability to counterbalance any U.S. dollar weakness," Malik said.For all the latest banking and finance news from the UAE and Gulf countries, follow us on Twitter and Linkedin, like us on Facebook and subscribe to our YouTube page, which is updated daily.
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