Dollar Peg - Saudi falls in line - 2

Khaleej Times Online
Gulf moves to deter revaluation bets after Fed cut
(Reuters)

1 November 2007

DUBAI - Saudi Arabia and other Gulf oil producers followed a US interest rate cut by lowering some borrowing costs on Thursday to try to relieve pressure on their dollar-pegged currencies without stoking inflation at home.


The Saudi riyal SAR led a retreat among Gulf currencies after the rate cuts made bets on exchange-rate appreciation less attractive, and signals from the Federal Reserve diminished expectations for cheaper money in the United States.

“If this does prove to be the end of the loosening cycle, that would be welcome by Gulf policymakers,” said Simon Williams, HSBC’s regional economist in Dubai.

“But rates are still low in nominal and real terms at a time when they should have been rising,” he said.

Most of the central bank moves reflected concerns about inflation, which is at decade highs across the Gulf, where economies are booming on a quadrupling of oil prices since 2002.

Of the five central banks that changed rates on Thursday, only Bahrain matched Wednesday’s quarter percentage point Fed easing with its benchmark rate.

Kuwait kept its benchmark steady as did Saudi Arabia, which also tightened bank lending curbs. Qatar left its main policy signal unchanged and the United Arab Emirates reduced rates by as much as 20 basis points.

“They are doing the minimum that they have to because of the pegs,” said Marios Maratheftis, Standard Chartered’s regional head of research.

Most Gulf currencies eased and the Saudi riyal SAR hit a three-week low after the central bank of the world’s largest oil exporter cut its reverse repo rate by 25 basis points.

The riyal had hit a 21-year high after the Saudi central bank opted to ignore the last Fed cut on Sept. 18, firing market speculation of an imminent revaluation.

Since then the International Monetary Fund has urged Saudi Arabia and its neighbours make sure that interest rates were consistent with their policy of shackling currencies to the tumbling dollar in the run up to monetary union.

Bids on the riyal fell as low as 3.7430 per dollar, its weakest since Oct. 8, after the Saudi rate cut. The central bank has officially kept the riyal stable at 3.75 to the dollar since June 1986, although on the market its latest 21-year peak was 3.7290 on Oct. 10.

The Saudi central bank also raised the reserve requirement for banks to 9 percent from 7 percent, to prevent lower borrowing costs from increasing lending and fuelling inflation that hit a seven-year high of 4.4 percent in August.

“This means that banks will have to keep more money in their vaults...,” said John Sfakianakis, chief economist at SABB bank, one of the bankers who had seen the central bank statement.

Dilemma

Saudi Arabia’s dilemma mirrors that of central banks around the region, which could soon be under less pressure to choose between deterring currency appreciation and fighting inflation.

A Reuters poll of primary dealers on Wednesday showed most expecting the Fed to keep rates on hold or end the easing cycle with another 25 basis point cut.

“If there are no more Fed cuts from here on this does take some of the pressure off these central banks,” said Caroline Grady, regional economist at Deutsche Bank.

Gulf central banks usually track US monetary policy to maintain the relative yield on their currencies. The Fed cut on Wednesday takes the gap between returns investors get on the Saudi riyal and dollar to its widest since 2002.

The Saudi central bank left its benchmark repurchase rate unchanged at 5.5 percent with the US federal funds rate at 4.5 percent. The average rate spread over the past 15 years has been 36 basis points, according to Deutsche Bank.

The Sept. 18 Fed cut divided the six states preparing for monetary union as early as 2010. Oman, Bahrain and Saudi Arabia ignored that move. Qatar and the UAE cut some rates with Kuwait, which has tracked the dinar against a currency basket since May.

Oman’s central bank is closed on Thursdays. Qatar cut its the deposit facility rate and Kuwait its repurchase rate by 25 basis points each. Bahrain reduced all borrowing costs by a quarter point. The UAE, which has no benchmark, cut certificate of deposit rates by 20 basis points.