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Tue 4 Mar 2008 03:38 PM

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Bets grow on Gulf revaluations

Currency forwards strengthen as investors renew bets weak dollar will force change to dollar peg.

Bets grow on Gulf revaluations
FORWARDS STRENGTHEN: Investors have renewed bets that the weak dollar will force Gulf states to change their dollar peg. (Getty Images)

Gulf Arab currency forwards strengthened on Tuesday as investors renewed bets that a weak dollar and fears of a US recession would compel Gulf Arab oil producers to change their dollar pegs.

Forward rates showed investors expecting the UAE dirham and Qatar riyal will rise 3.3% and 4.7%, respectively, in a year. The riyal spot rate held at a three-month peak of 3.63 per dollar.

"This is primarily a reaction to US dollar weakness," said Caroline Grady, Deustche Bank's regional economist.

The US dollar hit lifetime troughs against the euro and a basket of major currencies for a fifth trading day on Monday, weighed by concerns about US economic health and expectations the Federal Reserve will continue with deep interest rate cuts.

"Further dollar weakness will make the Gulf's inflation headaches even worse and highlights the inappropriateness of a US-led monetary policy," Grady said.

Gulf central banks, save Kuwait's, have been struggling to contain inflation at near-record peaks because the dollar pegs force them to shadow Fed rate cuts even though their economies are booming on a five-fold rise in oil prices since 2002.

Inflation hit a 27-year peak of 7% in Saudi Arabia in January and Qatar, contending with the steepest price rises, recorded inflation of 13.74% in the fourth quarter, just off a record.

Central bankers in Saudi Arabia, the world's largest oil exporter, and the UAE last week reiterated their commitment to retaining the pegs, saying they helped Gulf states attract foreign investments.

But Qatar's prime minister said last week the Gulf state was studying revaluing its currency among options to combat inflation.

The riyal is 30% undervalued and its weakness contributes to about 40% of inflation, Sheikh Hamad bin Jassim bin Jabr Al-Thani told newswire Reuters.

Qatar decided on Sunday to freeze rent increases for two years to tackle inflation, newspapers reported on Monday.

But with markets pricing in a 75-basis-point Fed cut by the end of March, price controls may not be enough to curb inflationary pressures, economists said.

"The rental caps can be helpful, but in order to manage inflation effectively the sources and not just the symptoms of inflation will need to be addressed," Standard Chartered Bank said in a note.

"Monetary and currency policies have a larger role to play," it said.

Kuwait, which severed its link to the US currency in May partly to reduce imported inflation, allowed its dinar to rise to a new 20-year peak on Tuesday.

Bets on the UAE dirham and Qatar riyal were even wider on a two-year horizon on Tuesday, showing expectations of appreciations of 4.6% and 5.5% in each currency, respectively. (Reuters)

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