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Wed 12 Dec 2007 10:57 AM

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Fed cuts rates, pressure on dirham mounts

UAE will likely change its monetary policy early next year, EFG-Hermes predicts.

The UAE central bank will likely change its monetary policy early next year, according a economist speaking after the US Federal Reserve cut interest rates again, heaping more pressure on Gulf Arab states to ditch their pegs to the dollar.

“We calculate a 60% chance of some form of change to currency pegging in the first six months of 2008,” Monica Malik, economist with EFG-Hermes, told ArabianBusiness.com on Wednesday.

The Fed on Tuesday lowered its Fed Funds Target Rate (FFTR) by 25 basis points.

The UAE responded to the Fed cut by reducing its over-night repurchase rate by 25 basis points to 4.25% on Wednesday, keeping their benchmark rate in line with the US.

Interest rates, which control ease of the flow of cash in the economy, are a key mechanism by which central banks can control inflation. Lower interest rates generally tend to loosen control on inflation while tighter rates can reign spiralling inflation back to manageable levels.

Simon Williams, economist for HSBC, said aligning UAE interest rates with those in the US will only add to inflationary pressures.

The US economy, plagued by the ongoing credit crisis and the subprime mortgage catastrophe, is lowering interest rates in an attempt to spur its economy on. This is the opposite of what Gulf states should be doing, according to Williams.

“The Gulf and US economies are more out of synch now than ever,” Williams told ArabianBusiness.com. “The Gulf states need higher rates to control inflation and curb the regional growth."

Inflation in the Gulf is reaching record highs with rates hitting 9.3% in the UAE last year and breaking through 5% to a 10-year high in Saudi Arabia. Qatar’s rate reached 14% at the end of the third quarter, while inflation stood at 7% in Oman and 6.2% in Kuwait in September.