Speculation the US would cut interest rates again on Wednesday sparked renewed calls for GCC central banks to depeg their currencies from the flailing US dollar to address record inflation across the Gulf.
Analysts said further aggressive moves by the US Federal Reserve, widely expected to make a 50 basis point cut, would further highlight the shortcomings of the dollar peg.
Analysts urged Gulf states to follow Kuwait’s lead and ditch the peg in favour of a basket of currencies, citing policy inflexibility as handicapping central banks’ ability to effectively fight inflation.
Gulf states’ peg to the dollar forces them to track US monetary policy at a time when the Federal Reserve is cutting interest rates to stimulate the economy. The Fed has reduced rates by 175 basis points since September.
Analysts said Gulf states would have to follow suite and match any rate cut by the Fed on Wednesday.
“A peg is still a peg and a lot of people forget that,” said Simon Williams, economist at HSBC. “Even if the currency is revalued that wouldn’t give Gulf states control over interest rates.
“Wherever you set the value you’re still going to have to follow US interest rate trends.”
Monica Malik, economist at EFG-Hermes, warned that revaluation would only fuel speculation over when the next one might follow, creating increased uncertainty in the international currency markets.
“Depegging would certainly be better,” she said.
EFG-Hermes forecasts a 60% likelihood that regional central banks will introduce currency reform this year.
“Further aggressive cuts [by the Fed] would indicate this to be the case,” Malik said.
Gulf states last week lowered interest rates, with Kuwait reducing its benchmark for the first time in 18 months, after an emergency US rate cut.
RELATED: Gulf slashes rates to keep pace with US
It was the Gulf’s most cautious response yet to the Fed. Only the UAE matched the 75 basis point Fed cut. Kuwait, Qatar, Saudi Arabia and Bahrain opted for reductions of half a percentage point.
Oman slashed its repurchase rate by 61 basis points and cut the yield on certificates of deposit on Tuesday in its first auction since the emergency US cut.
Gulf states’ peg to the tumbling dollar has been blamed for driving up inflation to record levels.
Investment bank Merrill Lynch said on Monday inflation in the UAE was in danger of hitting a 20-year high of 12% this year unless the dirham was revalued or depegged.
RELATED: UAE inflation in danger of hitting 12% this year
Merrill said inflation in Saudi Arabia might average 6% this year, compared with 4% last year, while in Oman inflation may rise to 7.2%, from 4.4% last year, and in Bahrain to 4.5% from 3%.
Kuwait was also likely to see inflation surge in 2008/09 to an average of 6.6% from 4.4% last year due to rising house prices, the bank said, while Qatar may see inflation drop slightly to 13% for 2008/09 from 14% last year.
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